##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10Q





(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended June 30, 2008

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission file number
0-30777





PACIFIC MERCANTILE BANCORP

(Exact
name of Registrant as specified in its charter)







|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 33-0898238                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|949 South Coast Drive, Suite 300, Costa Mesa, California       |  | 92626                                  
|(Address of principal executive offices)                       |  | (Zip Code)                             

(714) 438-2500

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed, since last year)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark whether the registrant is
a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.) (Check one):

Large accelerated filer    ̈             Accelerated filer   x             Non-accelerated filer    ̈             Smaller reporting company    ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ̈    No  x

APPLICABLE ONLY TO CORPORATE
ISSUERS:

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.

10,475,471 shares of Common Stock as of August 6, 2008









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##### Table of Contents

PACIFIC MERCANTILE BANCORP

QUARTERLY REPORT ON FORM 10Q

FOR

THE QUARTER ENDED JUNE 30, 2008

TABLE OF CONTENTS



|                                                                                                          |  |                                                                                                        |  |         
|--------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ |  | --------
|                                                                                                          |  |                                                                                                        |  | Page No.
|                                                                                                          |  |                                                                                                       
|Part I.                                                                                                   |  | Financial Information                                                                                  |  |         
|                                                                                                          |  |                                                                                                       
|Item 1.                                                                                                   |  | Financial Statements                                                                                   |  | 1       
|                                                                                                          |  |                                                                                                       
|                                                                                                          |  | Consolidated Statements of Financial Condition at June 30, 2008 and December 31, 2007                  |  | 1       
|                                                                                                          |  |                                                                                                       
|                                                                                                          |  | Consolidated Statements of Operations for the Three and Six Months ended June 30, 2008                 |  | 2       
|                                                                                                          |  |                                                                                                       
|                                                                                                          |  | Consolidated Statement of Comprehensive (Loss) Income for the Three and Six Months ended June 30, 2008 |  | 3       
|                                                                                                          |  |                                                                                                       
|                                                                                                          |  | Consolidated Statements of Cash Flows for the Six Months ended June 30, 2008                           |  | 4       
|                                                                                                          |  |                                                                                                       
|                                                                                                          |  | Notes to Consolidated Financial Statements                                                             |  | 5       
|                                                                                                          |  |                                                                                                       
|Item 2.                                                                                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                  |  | 14      
|                                                                                                          |  |                                                                                                       
|Item 3.                                                                                                   |  | Market Risk                                                                                            |  | 36      
|                                                                                                          |  |                                                                                                       
|Item 4.                                                                                                   |  | Controls and Procedures                                                                                |  | 36      
|                                                                                                          |  |                                                                                                       
|Part II.                                                                                                  |  |                                                                                                        |  |         
|                                                                                                          |  |                                                                                                       
|Item 1A.                                                                                                  |  | Risk Factors                                                                                           |  | 37      
|                                                                                                          |  |                                                                                                       
|Item 2.                                                                                                   |  | Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 37      
|                                                                                                          |  |                                                                                                       
|Item 4.                                                                                                   |  | Submission of Matters to a Vote of Security Holders                                                    |  | 38      
|                                                                                                          |  |                                                                                                       
|Item 6.                                                                                                   |  | Exhibits                                                                                               |  | 38      
|                                                                                                          | 
|Signatures                                                                                                |  | S1                                                                                                   
|                                                                                                          | 
|Exhibit Index                                                                                             |  | E1                                                                                                   
|                                                                                                         
|Exhibit 31.1 Certification of Chief Executive Officer under Section 302 of the SarbanesOxley Act of 2002
|                                                                                                         
|Exhibit 31.2 Certification of Chief Financial Officer under Section 302 of the SarbanesOxley Act of 2002
|                                                                                                         
|Exhibit 32.1 Certification of Chief Executive Officer under Section 906 of the SarbanesOxley Act of 2002
|                                                                                                         
|Exhibit 32.2 Certification of Chief Financial Officer under Section 906 of the SarbanesOxley Act of 2002



i



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##### Table of Contents

PART I.  FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PACIFIC MERCANTILE BANCORP
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

(Unaudited)



|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                       |  | June 30,2008 |           |   | December 31,2007 |  
|ASSETS                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                                |  | $            | 14,916    |   |                  | $ | 14,332    |  
|Federal funds sold                                                                                                                                                     |  |              | 50,105    |   |                  |   | 39,400    |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                              |  |              | 65,021    |   |                  |   | 53,732    |  
|Interest-bearing deposits with financial institutions                                                                                                                  |  |              | 198       |   |                  |   | 198       |  
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost                                                                                                         |  |              | 13,135    |   |                  |   | 12,662    |  
|Securities available for sale, at fair value                                                                                                                           |  |              | 230,145   |   |                  |   | 218,838   |  
|Loans (net of allowances of $7,073 and $6,126, respectively)                                                                                                           |  |              | 789,530   |   |                  |   | 773,071   |  
|Investment in unconsolidated subsidiaries                                                                                                                              |  |              | 682       |   |                  |   | 682       |  
|Accrued interest receivable                                                                                                                                            |  |              | 4,132     |   |                  |   | 4,431     |  
|Premises and equipment, net                                                                                                                                            |  |              | 1,314     |   |                  |   | 1,618     |  
|Other real estate owned                                                                                                                                                |  |              | 3,407     |   |                  |   | 425       |  
|Other assets                                                                                                                                                           |  |              | 15,133    |   |                  |   | 11,366    |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Total assets                                                                                                                                                           |  | $            | 1,122,697 |   |                  | $ | 1,077,023 |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                   |  |              |           |   |                  |   |           |  
|Deposits:                                                                                                                                                              |  |              |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                                                    |  | $            | 163,117   |   |                  | $ | 187,551   |  
|Interest-bearing                                                                                                                                                       |  |              | 597,421   |   |                  |   | 559,112   |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Total deposits                                                                                                                                                         |  |              | 760,538   |   |                  |   | 746,663   |  
|Borrowings                                                                                                                                                             |  |              | 244,718   |   |                  |   | 208,818   |  
|Accrued interest payable                                                                                                                                               |  |              | 2,903     |   |                  |   | 3,040     |  
|Other liabilities                                                                                                                                                      |  |              | 3,853     |   |                  |   | 4,113     |  
|Junior subordinated debentures                                                                                                                                         |  |              | 17,527    |   |                  |   | 17,527    |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                      |  |              | 1,029,539 |   |                  |   | 980,161   |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Commitments and contingencies (Note 2)                                                                                                                                 |  |              |          |   |                  |   |          |  
|Shareholders equity:                                                                                                                                                  |  |              |           |   |                  |   |           |  
|Preferred stock, no par value, 2,000,000 shares authorized, none issued                                                                                                |  |              |          |   |                  |   |          |  
|Common stock, no par value, 20,000,000 shares authorized, 10,478,289 and 10,492,049 shares issued and outstanding at June 30, 2008 and
December 31, 2007, respectively |  |              | 72,358    |   |                  |   | 72,381    |  
|Retained earnings                                                                                                                                                      |  |              | 24,967    |   |                  |   | 25,846    |  
|Accumulated other comprehensive loss                                                                                                                                   |  |              | (4,167    | ) |                  |   | (1,365    | )
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                             |  |              | 93,158    |   |                  |   | 96,862    |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  
|Total liabilities and shareholders equity                                                                                                                             |  | $            | 1,122,697 |   |                  | $ | 1,077,023 |  
|                                                                                                                                                                       |  |              |           |   |                  |   |           |  

The accompanying notes are an integral part of these consolidated financial statements.



1



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

(Dollars in thousands, except for per share data)

(Unaudited)



|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|----------------------------------------------------- |  | -------------------------- | ---------- | ------------------------ | ---- | - | ---------- |  | - | ---------- | - |  | - | ----------
|                                                      |  | Three Months EndedJune 30, |            | Six Months EndedJune 30,
|                                                      |  | 2008                       |            |                          | 2007 |   | 2008       |  |   | 2007      
|Interest income:                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Loans, including fees                                 |  | $                          | 12,240     |                          |      | $ | 13,957     |  | $ | 25,126     |   |  | $ | 27,670    
|Federal funds sold                                    |  |                            | 337        |                          |      |   | 1,181      |  |   | 619        |   |  |   | 1,754     
|Securities available for sale and stock               |  |                            | 2,549      |                          |      |   | 2,752      |  |   | 5,282      |   |  |   | 5,624     
|Interest-bearing deposits with financial institutions |  |                            | 2          |                          |      |   | 2          |  |   | 5          |   |  |   | 4         
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Total interest income                                 |  |                            | 15,128     |                          |      |   | 17,892     |  |   | 31,032     |   |  |   | 35,052    
|Interest expense:                                     |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Deposits                                              |  |                            | 5,792      |                          |      |   | 6,549      |  |   | 11,951     |   |  |   | 12,636    
|Borrowings                                            |  |                            | 2,821      |                          |      |   | 3,497      |  |   | 5,681      |   |  |   | 6,799     
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Total interest expense                                |  |                            | 8,613      |                          |      |   | 10,046     |  |   | 17,632     |   |  |   | 19,435    
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Net interest income                                   |  |                            | 6,515      |                          |      |   | 7,846      |  |   | 13,400     |   |  |   | 15,617    
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Provision for loan losses                             |  |                            | 2,741      |                          |      |   | 325        |  |   | 3,816      |   |  |   | 625       
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Net interest income after provision for loan losses   |  |                            | 3,774      |                          |      |   | 7,521      |  |   | 9,584      |   |  |   | 14,992    
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Noninterest income                                    |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Service fees on deposits and other banking services   |  |                            | 285        |                          |      |   | 198        |  |   | 497        |   |  |   | 385       
|Net gain on sale of securities available for sale     |  |                            | 52         |                          |      |   |           |  |   | 1,132      |   |  |   |          
|Net loss on sale of other real estate owned           |  |                            | (40        | )                        |      |   |           |  |   | (40        | ) |  |   |          
|Other                                                 |  |                            | 113        |                          |      |   | 117        |  |   | 295        |   |  |   | 283       
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Total noninterest income                              |  |                            | 410        |                          |      |   | 315        |  |   | 1,884      |   |  |   | 668       
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Noninterest expense                                   |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Salaries and employee benefits                        |  |                            | 2,832      |                          |      |   | 2,794      |  |   | 6,122      |   |  |   | 5,775     
|Occupancy                                             |  |                            | 697        |                          |      |   | 700        |  |   | 1,379      |   |  |   | 1,365     
|Equipment and furniture                               |  |                            | 282        |                          |      |   | 323        |  |   | 566        |   |  |   | 641       
|Data processing                                       |  |                            | 177        |                          |      |   | 158        |  |   | 350        |   |  |   | 324       
|Professional fees                                     |  |                            | 308        |                          |      |   | 225        |  |   | 581        |   |  |   | 400       
|Customer expense                                      |  |                            | 134        |                          |      |   | 186        |  |   | 248        |   |  |   | 345       
|FDIC expense                                          |  |                            | 145        |                          |      |   | 199        |  |   | 268        |   |  |   | 199       
|Other real estate owned expense                       |  |                            | 348        |                          |      |   |           |  |   | 429        |   |  |   |          
|Other operating expense                               |  |                            | 771        |                          |      |   | 808        |  |   | 1,447      |   |  |   | 1,444     
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Total noninterest expense                             |  |                            | 5,694      |                          |      |   | 5,393      |  |   | 11,390     |   |  |   | 10,493    
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|(Loss) income before income taxes                     |  |                            | (1,510     | )                        |      |   | 2,443      |  |   | 78         |   |  |   | 5,167     
|Income tax (benefit) provision                        |  |                            | (680       | )                        |      |   | 899        |  |   | (92        | ) |  |   | 2,029     
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Net (loss) income                                     |  | $                          | (830       | )                        |      | $ | 1,544      |  | $ | 170        |   |  | $ | 3,138     
|                                                      |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|(Loss) earnings per share                             |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Basic                                                 |  | $                          | (0.08      | )                        |      | $ | 0.15       |  | $ | 0.02       |   |  | $ | 0.30      
|Diluted                                               |  | $                          | (0.08      | )                        |      | $ | 0.14       |  | $ | 0.02       |   |  | $ | 0.29      
|Dividends paid per share                              |  |                            |           |                          |      |   |           |  | $ | 0.10       |   |  |   |          
|Weighted average number of shares:                    |  |                            |            |                          |      |   |            |  |   |            |   |  |   |           
|Basic                                                 |  |                            | 10,478,242 |                          |      |   | 10,396,999 |  |   | 10,484,634 |   |  |   | 10,361,396
|Diluted                                               |  |                            | 10,478,242 |                          |      |   | 10,682,401 |  |   | 10,641,513 |   |  |   | 10,689,768

The accompanying notes are an integral part of these consolidated financial statements.



2



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF
COMPREHENSIVE (LOSS) INCOME

(Dollars in thousands)

(Unaudited)



|                                                                                                                                   |  |                             |        |   |                           |   |       |      |  |   |        |   |  |   |       |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ----- | -
|                                                                                                                                   |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                                                                                   |  | 2008                        |        |   | 2007                      |   |       | 2008 |  |   | 2007   |  
|Net (loss) income                                                                                                                  |  | $                           | (830   | ) |                           | $ | 1,544 |      |  | $ | 170    |   |  | $ | 3,138 |  
|Other comprehensive loss, net of tax:                                                                                              |  |                             |        |   |                           |   |       |      |  |   |        |   |  |   |       |  
|Change in unrealized loss on securities available for sale, net of tax effect                                                      |  |                             | (2,709 | ) |                           |   | (936  | )    |  |   | (2,825 | ) |  |   | (636  | )
|Change in net unrealized gain (loss) and prior service benefit (cost) on supplemental executive retirement plan, net of tax
effect |  |                             | 12     |   |                           |   | 10    |      |  |   | 23     |   |  |   | (93   | )
|                                                                                                                                   |  |                             |        |   |                           |   |       |      |  |   |        |   |  |   |       |  
|Total comprehensive (loss) income                                                                                                  |  | $                           | (3,527 | ) |                           | $ | 618   |      |  | $ | (2,632 | ) |  | $ | 2,409 |  
|                                                                                                                                   |  |                             |        |   |                           |   |       |      |  |   |        |   |  |   |       |  

The accompanying notes are an integral part of these consolidated financial statements.



3



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
CASH FLOWS

(Dollars in thousands)



|                                                                                                                                  |      |                          |          |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------- | ---- | ------------------------ | -------- | ---- |  | - | ------- | -
|                                                                                                                                  |      | Six Months EndedJune 30, |         
|                                                                                                                                  | 2008 |                          |          | 2007 | 
|Cash Flows From Operating Activities:                                                                                             |      |                          |          |      |  |   |         |  
|Income from operations                                                                                                            |      | $                        | 170      |      |  | $ | 3,138   |  
|Adjustments to reconcile net income to net cash provided by operating activities:                                                 |      |                          |          |      |  |   |         |  
|Depreciation and amortization                                                                                                     |      |                          | 338      |      |  |   | 412     |  
|Provision for loan losses                                                                                                         |      |                          | 3,816    |      |  |   | 625     |  
|Net amortization of premium on securities                                                                                         |      |                          | 153      |      |  |   | 36      |  
|Net gains on sales of securities available for sale                                                                               |      |                          | (1,132   | )    |  |   |        |  
|Mark to market loss adjustment of equity securities                                                                               |      |                          | 28       |      |  |   | 50      |  
|Net loss on sales of other real estate owned                                                                                      |      |                          | 40       |      |  |   |        |  
|Write down of other real estate owned                                                                                             |      |                          | 260      |      |  |   |        |  
|Stock-based compensation expense                                                                                                  |      |                          | 310      |      |  |   | 278     |  
|Net decrease in accrued interest receivable                                                                                       |      |                          | 299      |      |  |   | 122     |  
|Net increase in other assets                                                                                                      |      |                          | (1,806   | )    |  |   | (1,230  | )
|Net (decrease) increase in accrued interest payable                                                                               |      |                          | (137     | )    |  |   | 942     |  
|Net decrease in other liabilities                                                                                                 |      |                          | (222     | )    |  |   | (657    | )
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Net cash provided by operating activities                                                                                         |      |                          | 2,117    |      |  |   | 3,716   |  
|Cash Flows From Investing Activities:                                                                                             |      |                          |          |      |  |   |         |  
|Maturities of and principal payments received for securities available for sale and other stock                                   |      |                          | 22,496   |      |  |   | 19,979  |  
|Purchase of securities available for sale and other stock                                                                         |      |                          | (118,482 | )    |  |   | (4,541  | )
|Proceeds from sale of securities available for sale and other stock                                                               |      |                          | 80,354   |      |  |   |        |  
|Proceeds from sales of other real estate owned                                                                                    |      |                          | 943      |      |  |   |        |  
|Net increase in loans                                                                                                             |      |                          | (24,500  | )    |  |   | (209    | )
|Purchases of premises and equipment                                                                                               |      |                          | (34      | )    |  |   | (102    | )
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Net cash (used) provided in investing activities                                                                                  |      |                          | (39,223  | )    |  |   | 15,127  |  
|Cash Flows From Financing Activities:                                                                                             |      |                          |          |      |  |   |         |  
|Net increase in deposits                                                                                                          |      |                          | 13,875   |      |  |   | 49,893  |  
|Proceeds from exercise of stock options                                                                                           |      |                          |         |      |  |   | 923     |  
|Cash dividends paid                                                                                                               |      |                          | (1,049   | )    |  |   |        |  
|Net cash paid for share buyback                                                                                                   |      |                          | (331     | )    |  |   | (688    | )
|Net increase in borrowings                                                                                                        |      |                          | 35,900   |      |  |   | 23,886  |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Net cash provided by financing activities                                                                                         |      |                          | 48,395   |      |  |   | 74,014  |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Net increase in cash and cash equivalents                                                                                         |      |                          | 11,289   |      |  |   | 92,857  |  
|Cash and Cash Equivalents, beginning of period                                                                                    |      |                          | 53,732   |      |  |   | 26,304  |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Cash and Cash Equivalents, end of period                                                                                          |      | $                        | 65,021   |      |  | $ | 119,161 |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Supplementary Cash Flow Information:                                                                                              |      |                          |          |      |  |   |         |  
|Cash paid for interest on deposits and other borrowings                                                                           |      | $                        | 17,768   |      |  | $ | 18,493  |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Cash paid for income taxes                                                                                                        |      | $                        | 1,420    |      |  | $ | 3,000   |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Non-Cash Investing Activities:                                                                                                    |      |                          |          |      |  |   |         |  
|Net (increase) decrease in net unrealized losses and prior year service cost on supplemental employee retirement plan, net of
tax |      | $                        | 23       |      |  | $ | (93     | )
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Net increase in net unrealized gains and losses on securities held for sale, net of income tax                                    |      | $                        | (2,826   | )    |  | $ | (636    | )
|                                                                                                                                  |      |                          |          |      |  |   |         |  
|Other real estate owned acquired                                                                                                  |      | $                        | 4,225    |      |  | $ |        |  
|                                                                                                                                  |      |                          |          |      |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Consolidated
Financial Statements

(Unaudited)

1. Nature of Business

Pacific Mercantile Bancorp (PMBC) is a bank holding company which, through its wholly
owned subsidiary, Pacific Mercantile Bank (the Bank) is engaged in the commercial banking business in Southern California. PMBC is registered as a one bank holding company under the United States Bank Holding Company Act of 1956, as
amended. The Bank is chartered by the California Department of Financial Institutions (the DFI) and is a member of and subject to regulation by the Federal Reserve Bank of San Francisco (FRB). In addition, the deposit
accounts of the Banks customers are insured by the Federal Deposit Insurance Corporation (FDIC) up to the maximum amount allowed by law. PMBC and the Bank, together, shall sometimes be referred to in this report as the
Company or as we, us or our.

Substantially all of our operations are conducted and
substantially all our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues and expenses, and earnings. The Bank provides a full range of banking services to small and medium-size businesses, professionals
and the general public in Orange, Los Angeles, San Bernardino and San Diego Counties of California and is subject to competition from other financial institutions and from financial services organizations conducting operations in those same markets.

During 2002, we organized six business trusts, under the names Pacific Mercantile Capital Trust I, PMB Capital Trust I, and PMB Statutory
Trust III, respectively, to facilitate our issuance of $5.155 million, $5.155 million and $7.217 million, respectively, principal amount of junior subordinated debentures, all with maturity dates in 2032. In October 2004, we organized PMB Capital
Trust III to facilitate our issuance of an additional $10 million principal amount of junior subordinated debentures, with a maturity date in 2034. In accordance with applicable accounting standards, the financial statements of these trusts are not
included in the Companys consolidated financial statements. See Note 2: Significant Accounting Policies  Principles of Consolidation below.

In July 2007, we redeemed the $5.155 million principal amount of junior subordinated debentures issued in conjunction with the organization of Pacific Mercantile Capital Trust I and in August 2007, we redeemed the
$5.155 million principal amount of junior subordinated debentures issued in conjunction with the organization of PMB Capital Trust I. Those trusts were dissolved as a result of those redemptions.

2. Significant Accounting Policies

The accompanying
unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10Q and, therefore, do not include all footnotes that would be required for a full presentation of financial position, results of
operations, changes in cash flows and comprehensive income (loss) in accordance with generally accepted accounting principles in the United States (GAAP). However, these interim financial statements reflect all adjustments (consisting of
normal recurring adjustments and accruals) which, in the opinion of our management, are necessary for a fair presentation of our financial position as of the end of and our results of operation for the interim periods presented.

These unaudited consolidated financial statements have been prepared on a basis consistent with prior periods, and should be read in conjunction with our
audited consolidated financial statements as of and for the year ended December 31, 2007, and the notes thereto, included in our Annual Report on Form 10K for the fiscal year ended December 31, 2007, as filed with the Securities and
Exchange Commission under the Securities Exchange Act of 1934.

Our consolidated financial position at June 30, 2008, and the
consolidated results of operations for the three and six month periods ended June 30, 2008, are not necessarily indicative of what our financial position will be as of the end of, or of the results of our operations that may be expected for any
other interim period during or for, the full year ending December 31, 2008.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

2. Significant Accounting Policies (Cont.-)

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. For the fiscal periods covered by this
Report, those estimates related primarily to the determination of the allowance for loan losses, the fair value of securities available for sale, and the valuation of deferred tax assets. If circumstances or financial trends on which those estimates
were based were to change in the future or there were to occur any currently unanticipated events affecting the amounts of those estimates, our future financial position or results of operation could differ, possibly materially, from those expected
at the current time.

Principles of Consolidation

The consolidated financial statements for the three and six month periods ended June 30, 2008 and 2007, include the accounts of PMBC and its wholly
owned subsidiary, Pacific Mercantile Bank.

Nonperforming Loans and Other Assets

At June 30, 2008, loans that were 90 days past due totaled $10.8 million, and loans classified as nonaccrual and impaired were $11.6 million. This
compares to $7.7 million of loans that were 90 days past due and $8.0 million of loans classified as nonaccrual and impaired as of December 31, 2007. At June 30, 2008 and December 31, 2007, we had $3.3 million and $300,000,
respectively, of accruing restructured troubled debt loans.

Earnings Per Share (EPS)

Basic EPS excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted to common stock that would then share in our earnings. For the three and six month periods ended June 30,
2008, stock options to purchase 1,057,744 and 527,943 shares, respectively, were not considered in computing diluted earnings per common share because they were antidilutive.

The following table shows how we computed basic and diluted EPS for the three and six month periods ended June 30, 2008 and 2007.



|                                                          |  |                                    |        |                                  |      |   |        |  |      |        |  |   |       
|--------------------------------------------------------- |  | ---------------------------------- | ------ | -------------------------------- | ---- | - | ------ |  | ---- | ------ |  | - | ------
|                                                          |  | For the Three Months EndedJune 30, |        | For the Six Months EndedJune 30,
|(In thousands, except earnings per share data)            |  | 2008                               |        |                                  | 2007 |   | 2008   |  | 2007
|Net (loss) income available for common shareholders (A)   |  | $                                  | (830   | )                                |      | $ | 1,544  |  | $    | 170    |  | $ | 3,138 
|                                                          |  |                                    |        |                                  |      |   |        |  |      |        |  |   |       
|Weighted average outstanding shares of common stock (B)   |  |                                    | 10,478 |                                  |      |   | 10,397 |  |      | 10,485 |  |   | 10,361
|Dilutive effect of employee stock options and warrants(1) |  |                                    |       |                                  |      |   | 285    |  |      | 157    |  |   | 329   
|                                                          |  |                                    |        |                                  |      |   |        |  |      |        |  |   |       
|Common stock and common stock equivalents (C)             |  |                                    | 10,478 |                                  |      |   | 10,682 |  |      | 10,642 |  |   | 10,690
|                                                          |  |                                    |        |                                  |      |   |        |  |      |        |  |   |       
|Earnings per share:                                       |  |                                    |        |                                  |      |   |        |  |      |        |  |   |       
|Basic (A/B)                                               |  | $                                  | (0.08  | )                                |      | $ | 0.15   |  | $    | 0.02   |  | $ | 0.30  
|Diluted (A/C)                                             |  | $                                  | (0.08  | )                                |      | $ | 0.14   |  | $    | 0.02   |  | $ | 0.29  

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and
liabilities, such as unrealized gains and losses on securities available for sale and unrealized actuarial gains and losses on the supplemental executive compensation plan, are reported as a separate component of the equity section of the balance
sheet, net of income taxes, and such items, along with net income, are components of comprehensive income.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

2. Significant Accounting Policies (Cont.-)

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS 157). SFAS 157 defines fair value,
establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured
at fair value, and therefore, does not expand the use of fair value in any new circumstances. SFAS 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a
fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and lowest priority to unobservable data. SFAS 157 is effective for
fiscal years beginning after November 15, 2007. The Company adopted SFAS 157 as of January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements or results of operations of the Company.

On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities,
including an amendment of FASB Statement No. 115, (SFAS 159). SFAS 159 provides an alternative measurement treatment for certain financial assets and financial liabilities, under an instrument-by-instrument election, that permits fair
value to be used for both initial and subsequent measurement, with changes in fair value recognized in earnings. SFAS 159 is effective beginning January 1, 2008 and we adopted SFAS 159 on January 1, 2008. The Company chose not to elect the
option to measure the eligible financial assets and liabilities at fair value.

In December 2007, the SEC issued Staff Accounting Bulletin
No. 110 (SAB No. 110), Certain Assumptions Used in Valuation Methods, which extends the use of the simplified method, under certain circumstances, in developing an estimate of expected term of plain
vanilla share options in accordance with SFAS No. 123R. Prior to SAB No. 110, SAB No. 107 stated that the simplified method was only available for grants made up to December 31, 2007. The Company used the simplified method
in developing an estimate of expected term of stock options. Beginning January 1, 2008 the Company began to use historical data based on awards vesting period and the award recipients exercise history to estimate the expected life
of the share options grants.

In May 2008, the FASB issued Statement of Financial Accounting Standard No. 162, or SFAS No. 162,
The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS No. 162 will become effective 60 days following the SECs approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not expect the adoption of this statement to have a material effect on its consolidated
financial statements.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

2. Significant Accounting Policies (Cont.-)

Commitments and Contingencies

To meet the financing needs of our customers in the normal course of business, we are a party to financial instruments with off-balance sheet risk.
These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial
statements. At June 30, 2008, loan commitments and letters of credit totaled $211 million and $6 million, respectively. The contractual amount of a credit-related financial instrument such as a commitment to extend credit, a credit-card
arrangement or a letter of credit represents the amounts of potential accounting loss should the commitment be fully drawn upon, the customer default, and the value of any existing collateral securing the customers payment obligation become
worthless.

As a result, we use the same credit policies in making commitments to extend credit and conditional obligations as we do for
on-balance sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. We evaluate each customers creditworthiness on a case-by-case basis, using the same credit underwriting standards that are employed in making commercial loans. The amount of collateral obtained, if any, upon an extension of
credit is based on managements credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, real estate and income-producing commercial properties.

In the ordinary course of business, we are subject to legal actions normally associated with financial institutions. At June 30, 2008, we were not a
party to any pending legal action that is expected to be material to our consolidated financial condition or results of operations.

3. Stock-Based
Employee Compensation Plans

Effective March 2, 1999, our Board of Directors adopted, and in January 2000 our shareholders
approved, the 1999 Stock Option Plan (the 1999 Plan). That Plan authorizes the granting of options to directors, officers and other key employees that entitle them to purchase shares of common stock of the Company at a price per share
equal to or above the fair market value of the Companys shares on the respective grant dates of the awards. Options may vest immediately or over various periods, generally ranging up to five years, as determined by the Compensation Committee
of our Board of Directors at the time it approves the grant of options under the 1999 Plan. Options may be granted for terms of up to 10 years, but will terminate sooner upon or shortly after a termination of service occurring prior to the
expiration of the term of the option. A total of 1,248,230 shares were authorized for issuance under the 1999 Plan (which number has been adjusted for stock splits effectuated subsequent to the Plans adoption).

Effective February 17, 2004, the Board of Directors adopted the Pacific Mercantile Bancorp 2004 Stock Incentive Plan (the 2004 Plan),
which was approved by the Companys shareholders in May 2004. That Plan authorizes the granting of options and rights to purchase restricted stock to directors, officers and other key employees, that entitle them to purchase shares of common
stock of the Company at, in the case of stock options, a price per share equal to or above the fair market value of the Companys shares on the date the option is granted or, in case of stock purchase rights, at prices and on such terms as are
fixed by the Compensation Committee of the Board of Directors at the time the rights are granted. Options and restricted stock purchase rights may vest immediately or over various periods generally ranging up to five years, or based on the
achievement of specified performance goals, as determined by the Compensation Committee at the time it grants the options or the stock purchase rights. Options may be granted under the 2004 Plan for terms of up to 10 years after the grant date, but
will terminate sooner upon or shortly after a termination of service occurring prior to the expiration of the term of the option. The Company will become entitled to repurchase any unvested shares subject to restricted purchase rights in the event
of a termination of employment or service of the holder of the stock purchase right or in the event the holder fails to achieve any goals that are required to be met as a condition of vesting. A total of 400,000 shares were authorized for issuance
under the 2004 Plan.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

3. Stock-Based Employee Compensation Plans (Cont.-)

Effective April 15, 2008, the Board of
Directors adopted the Pacific Mercantile Bancorp 2008 Equity Incentive Plan (the 2008 Plan), which was approved by the Companys shareholders in May 2008. That Plan authorizes the granting of stock options, and rights to purchase
restricted stock to directors, officers and other key employees, that entitle them to purchase shares of common stock of the Company at, in the case of stock options, a price per share equal to or above the fair market value of the Companys
shares on the date the option is granted or, in case of stock purchase rights, at prices and on such terms as are fixed by the Compensation Committee of the Board of Directors at the time the rights are granted. In addition, the 2008 Plan authorizes
the Compensation Committee of the Board to grant stock appreciation rights (SARs), which entitle the recipient of such rights to receive a cash payment in an amount equal to the difference between the fair market value of the
Companys shares on the date of vesting or exercise and a base price which, in most cases, will be equal to fair market value of the Companys shares on the date of grant. In lieu of such cash payment, the Company may deliver
shares of common stock with a fair market value, on the date of exercise, equal to the amount of such payment. Options, restricted stock purchase rights and SARs ordinarily will vest over various periods generally ranging up to five years, or based
on the achievement of specified performance goals, as determined by the Compensation Committee at the time it grants the options, the stock purchase rights or the SARs. However, the Committee has the authority to grant options that are fully vested
at the time of grant. Options and SARs may be granted under the 2008 Plan for terms of up to 10 years after the grant date, but will terminate sooner upon or shortly after a termination of service occurring prior to the expiration of the term of the
option or SAR. The Company will become entitled to repurchase any unvested shares subject to restricted purchase rights in the event of a termination of employment or service of the holder of the stock purchase right or in the event the holder fails
to achieve any goals that are required to be met as a condition of vesting. A total of 400,000 shares are authorized for issuance under the 2008 Equity Incentive Plan.

In December 2004, Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment, which requires companies or other organizations that grant stock options
or other equity compensation awards to employees to recognize, in their financial statements, the fair value of those options and shares as compensation cost over their respective service (vesting) periods. In the case of the Company, SFAS
No. 123(R) became effective January 1, 2006 and, as of that date, we adopted the fair value recognition provisions of SFAS No. 123(R), using the modified-prospective-transition method. Under this transition method, equity compensation
expense includes: (a) compensation expense for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on their grant date fair values estimated in accordance with the original provisions of SFAS
No. 123, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on their grant date fair values estimated in accordance with the provisions of SFAS No. 123(R). Since stock-based
compensation that is recognized in the statement of income is to be determined based on the equity compensation awards that we expect will ultimately vest, that compensation expense has been reduced for estimated forfeitures of unvested options that
typically occur due to terminations of employment of optionees. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods in the event actual forfeitures differ from those
estimates. For purposes of determining stock-based compensation expense for the quarter ended June 30, 2008, we estimated no forfeitures of options held by the Companys directors and all other forfeitures to be 21% of the unvested options
issued.

The fair values of the options that were outstanding under the 1999, 2004 and 2008 Plans were estimated as of their respective
dates of grant using the Black-Scholes option-pricing model. The following table summarizes the weighted average assumptions used for grants in the following periods:



|                                                             |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  
|------------------------------------------------------------ |  | -------------------------- | ---- | - | ------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                                                             |  | Three Months EndedJune 30, |      |   | Six Months EndedJune 30, |  
|Assumptions with respect to:                                 |  | 2008                       |      |   | 2007                     |   |      | 2008 |  |   | 2007 |  
|Expected volatility                                          |  |                            | 30   | % |                          |   | 30   | %    |  |   | 30   | % |  |   | 30   | %
|Risk-free interest rate                                      |  |                            | 3.06 | % |                          |   | 4.62 | %    |  |   | 3.06 | % |  |   | 4.67 | %
|Expected dividends                                           |  |                            | 1.53 | % |                          |   | 1.35 | %    |  |   | 1.53 | % |  |   | 1.24 | %
|Expected term (years)                                        |  |                            | 6.9  |   |                          |   | 6.5  |      |  |   | 6.9  |   |  |   | 6.5  |  
|Weighted average fair value of options granted during period |  | $                          | 2.74 |   |                          | $ | 4.86 |      |  | $ | 2.74 |   |  | $ | 5.22 |  



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##### Table of Contents

NOTES TO FINANCIAL STATEMENTS (Cont.-)

3. Stock-Based Employee Compensation Plans (Cont.-)

The following tables summarize the share option
activity under the Companys 1999, 2004 and 2008 Plans during the six month periods ended June 30, 2008 and 2007, respectively. No options or other equity grants have been made to date under the 2008 Plan.



|                             |  |                                   |   |      |                                        |       |                                   |           |   |                                        |   |      
|---------------------------- |  | --------------------------------- | - | ---- | -------------------------------------- | ----- | --------------------------------- | --------- | - | -------------------------------------- | - | -----
|                             |  | Six Months Ended June 30,        
|                             |  | 2008                              |   | 2007
|                             |  | Number ofShares Subjectto Options |   |      | Weighted-AverageExercisePricePer Share |       | Number ofShares Subjectto Options |           |   | Weighted-AverageExercisePricePer Share
|OutstandingJanuary 1,       |  | 1,133,139                         |   |      | $                                      | 9.82  |                                   | 1,366,924 |   |                                        | $ | 9.11 
|Granted                      |  | 5,500                             |   |      |                                        | 8.91  |                                   | 23,800    |   |                                        |   | 15.05
|Exercised                    |  | (66,062                           | ) |      |                                        | 5.23  |                                   | (151,898  | ) |                                        |   | 6.08 
|Forfeited/Canceled           |  | (14,833                           | ) |      |                                        | 15.50 |                                   | (24,000   | ) |                                        |   | 17.38
|                             |  |                                   |   |      |                                        |       |                                   |           |   |                                        |   |      
|OutstandingJune 30,         |  | 1,057,744                         |   |      |                                        | 10.03 |                                   | 1,214,826 |   |                                        |   | 9.44 
|                             |  |                                   |   |      |                                        |       |                                   |           |   |                                        |   |      
|Options ExercisableJune 30, |  | 895,581                           |   |      | $                                      | 9.29  |                                   | 950,327   |   |                                        | $ | 8.28 
|                             |  |                                   |   |      |                                        |       |                                   |           |   |                                        |   |      

The aggregate intrinsic values of options exercised during the six months ended June 30, 2008
and 2007, were $225,000 and $1.2 million, respectively. Total fair values of vested options at June 30, 2008 and 2007, were $358,000 and $375,000, respectively.



|                        |  |                                       |  |                                       |  |                               |       |                                                  |      |        |         |                                |   |      
|----------------------- |  | ------------------------------------- |  | ------------------------------------- |  | ----------------------------- | ----- | ------------------------------------------------ | ---- | ------ | ------- | ------------------------------ | - | -----
|                        |  | Options Outstandingas ofJune 30, 2008 |  | Options Exercisableas ofJune 30, 2008
|Range of Exercise Price |  | Vested                                |  | Unvested                              |  | Weighted-AverageExercisePrice |       | Weighted-AverageRemainingContractualLife (Years) |      | Shares |         | Weighted-AverageExercise Price
|$ 4.00  $5.99          |  | 2,500                                 |  |                                      |  | $                             | 4.00  |                                                  | 0.67 |        | 2,500   |                                | $ | 4.00 
|$ 6.00  $9.99          |  | 527,001                               |  | 5,800                                 |  |                               | 7.32  |                                                  | 2.36 |        | 527,001 |                                |   | 7.31 
|$10.00  $12.99         |  | 282,942                               |  | 48,158                                |  |                               | 11.23 |                                                  | 5.65 |        | 282,942 |                                |   | 11.22
|$13.00  $17.99         |  | 71,138                                |  | 90,205                                |  |                               | 15.07 |                                                  | 7.43 |        | 71,138  |                                |   | 15.05
|$18.00  $18.84         |  | 12,000                                |  | 18,000                                |  |                               | 18.09 |                                                  | 7.59 |        | 12,000  |                                |   | 18.09
|                        |  |                                       |  |                                       |  |                               |       |                                                  |      |        |         |                                |   |      
|                        |  | 895,581                               |  | 162,163                               |  | $                             | 10.03 |                                                  | 4.31 |        | 895,581 |                                | $ | 9.29 
|                        |  |                                       |  |                                       |  |                               |       |                                                  |      |        |         |                                |   |      

The aggregate intrinsic values of options that were outstanding and exercisable under the 1999 and
2004 Plans at June 30, 2008, and 2007, were $296,000 and $6.0 million, respectively. A summary of the status of the unvested options as of December 31, 2007, and changes during the six month period ended June 30, 2008, are set forth
in the following table.



|                              |  |                                   |   |  |                                      |     
|----------------------------- |  | --------------------------------- | - |  | ------------------------------------ | ----
|                              |  | Number ofShares Subjectto Options |   |  | Weighted-AverageGrant DateFair Value
|Unvested at December 31, 2007 |  | 231,474                           |   |  | $                                    | 5.74
|Granted                       |  | 5,500                             |   |  |                                      | 2.74
|Vested                        |  | (59,978                           | ) |  |                                      | 5.46
|Forfeited/Canceled            |  | (14,833                           | ) |  |                                      | 6.19
|                              |  |                                   |   |  |                                      |     
|Unvested at June 30, 2008     |  | 162,163                           |   |  | $                                    | 5.70
|                              |  |                                   |   |  |                                      |     



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

3. Stock-Based Employee Compensation Plans (Cont.-)

The aggregate amounts charged against income in
relation to stock-based compensation awards were $154,000 and $310,000 for the three and six months ended June 30, 2008, respectively. At June 30, 2008, compensation expense related to non-vested stock option grants were expected to be
recognized in the respective amounts set forth in the table below:



|                                |  |                                 |    
|------------------------------- |  | ------------------------------- | ---
|                                |  | Stock BasedCompensation Expense
|                                |  | (In thousands)                 
|Remainder of 2008               |  | $                               | 310
|For the year ended December 31, |  |                                 |    
|2009                            |  |                                 | 238
|2010                            |  |                                 | 106
|2011                            |  |                                 | 53 
|2012                            |  |                                 | 10 
|2013                            |  |                                 | 1  
|                                |  |                                 |    
|Total                           |  | $                               | 718
|                                |  |                                 |    

4. Employee Benefit Plan

The Company has established a Supplemental Retirement Plan (SERP) for its Chief Executive Officer. Net periodic benefit costs are charged to employee benefits expense in the consolidated statements of
operations to recognize the Companys expense in respect of that Plan. The components of net periodic benefit cost for the SERP are set forth in the table below:



|                                   |  |                            |    |                          |   |      |  |      |     |  |   |    
|---------------------------------- |  | -------------------------- | -- | ------------------------ | - | ---- |  | ---- | --- |  | - | ---
|                                   |  | Three Months EndedJune 30, |    | Six Months EndedJune 30,
|                                   |  | 2008                       |    | 2007                     |   | 2008 |  | 2007
|                                   |  | (In thousands)             |    | (In thousands)          
|Service cost                       |  | $                          | 46 |                          | $ | 42   |  | $    | 91  |  | $ | 83 
|Interest cost                      |  |                            | 26 |                          |   | 22   |  |      | 52  |  |   | 41 
|Expected return on plan assets     |  |                            |   |                          |   |     |  |      |    |  |   |   
|Amortization of prior service cost |  |                            | 4  |                          |   | 4    |  |      | 8   |  |   | 8  
|Amortization of net actuarial loss |  |                            | 16 |                          |   | 14   |  |      | 32  |  |   | 28 
|                                   |  |                            |    |                          |   |      |  |      |     |  |   |    
|Net periodic SERP cost             |  | $                          | 92 |                          | $ | 82   |  | $    | 183 |  | $ | 160
|                                   |  |                            |    |                          |   |      |  |      |     |  |   |    

5. Income Taxes

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109, (FIN 48) on
January 1, 2007. We did not have any unrecognized tax benefits as of June 30, 2008 and June 30, 2007.

We file income tax
returns with the U.S. federal government and the state of California. As of June 30 and January 1, 2008, we were subject to examination by the Internal Revenue Service with respect to our U.S. federal tax returns and the Franchise Tax
Board for California, for the 2004-2006 tax years. We do not believe there will be any material changes in our unrecognized tax positions over the next 12 months.

Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We did not have any accrued interest or penalties associated with any unrecognized
tax benefits, and no interest expense was recognized during the six months ended June 30, 2008 and 2007. Our effective tax rate differs from the federal statutory rate primarily due to the non-deductibility of certain expenses recognized for
financial reporting purposes and state taxes.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

6. Fair Value

We use fair value measurements to record fair value adjustments to certain assets and
liabilities and to determine fair value disclosures. Securities available for sale and the employee benefit plan are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other
assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy. Under SFAS No. 157, we group assets and liabilities at fair value in six levels, based on the markets in
which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:



|        |  |                                                                                                                                                                                                                                                                                                                                                                                   
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Level 1 |  | Valuation is based upon quoted prices for identical instruments traded in active markets.                                                                                                                                                                                                                                                                                         
|        | 
|Level 2 |  | Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation
techniques for which all significant assumptions are observable in the market.                                                                                                      
|        | 
|Level 3 |  | Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions
that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following is a description of valuation methodologies used for assets and liabilities recorded
at fair value.

Assets

Investment Securities Available for Sale. Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available,
fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as
credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds.
Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as level 3 include asset-backed securities in less liquid markets.

Impaired Loans. SFAS No. 157 applies to loans measured for impairment in accordance with SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, including impaired loans measured at an observable market price (if available), at the fair value of the loans collateral (if the loan is collateral dependent). The fair value of an impaired loan is estimated using
one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance for possible losses represent loans for which the fair
value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan as nonrecurring
Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the impaired loan as nonrecurring Level 3.

Foreclosed Assets. Foreclosed assets are adjusted to the lower of cost or fair value, less estimated cost to sell, at the time the
loans are transferred to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less estimated cost to sell. Fair value is based upon independent market prices, appraised values of the collateral
or managements estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the foreclosed asset as nonrecurring Level 2. When an appraised
value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the foreclosed asset as nonrecurring Level 3.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)

6. Fair Value (Cont.-)

The following table shows the recorded amounts of assets measured at fair
value on a recurring basis.



|                                         |  |                                |         |         |   |         |  |         |         |  |   |      
|---------------------------------------- |  | ------------------------------ | ------- | ------- | - | ------- |  | ------- | ------- |  | - | -----
|                                         |  | At June 30, 2008(in thousands)
|                                         |  | Total                          |         | Level 1 |   | Level 2 |  | Level 3
|Assets at Fair Value:                    |  |                                |         |         |   |         |  |         |         |  |   |      
|Investment securities available for sale |  | $                              | 230,145 |         | $ | 1,722   |  | $       | 221,111 |  | $ | 7,312

The changes in Level 3 assets measured at fair value on a recurring basis are summarized in the
following table:



|                                                                           |  |                                         |       |  
|-------------------------------------------------------------------------- |  | --------------------------------------- | ----- | -
|                                                                           |  | Investment SecuritiesAvailable for Sale |      
|Balance of recurring Level 3 instruments at January 1, 2008 (in thousands) |  | $                                       | 8,436 |  
|Total gains or losses (realized/unrealized):                               |  |                                         |       |  
|Included in earnings-realized                                              |  |                                         |      |  
|Included in earnings-unrealized                                            |  |                                         |      |  
|Included in other comprehensive income                                     |  |                                         | (645  | )
|Purchases, sales, issuances and settlements, net                           |  |                                         | (479  | )
|Transfers in and/or out of Level 3                                         |  |                                         |      |  
|                                                                           |  |                                         |       |  
|Balance of recurring Level 3 assets at June 30, 2008                       |  | $                                       | 7,312 |  
|                                                                           |  |                                         |       |  

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally
accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at a fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the
table below.



|                      |  |                                |        |         |   |         |  |         |       |  |   |      
|--------------------- |  | ------------------------------ | ------ | ------- | - | ------- |  | ------- | ----- |  | - | -----
|                      |  | At June 30, 2008(in thousands)
|                      |  | Total                          |        | Level 1 |   | Level 2 |  | Level 3
|Assets at Fair Value: |  |                                |        |         |   |         |  |         |       |  |   |      
|Loans                 |  | $                              | 11,627 |         | $ |        |  | $       | 4,470 |  | $ | 7,157
|Other assets(1)       |  |                                | 3,407  |         |   |        |  |         | 3,407 |  |   |     
|                      |  |                                |        |         |   |         |  |         |       |  |   |      
|Total                 |  | $                              | 15,034 |         | $ |        |  | $       | 7,877 |  | $ | 7,157
|                      |  |                                |        |         |   |         |  |         |       |  |   |      



|(1) | Includes foreclosed assets
|--- | --------------------------



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Introduction

Pacific Mercantile Bancorp is a bank holding company that owns all of the stock of
Pacific Mercantile Bank (the Bank), which is a commercial bank that provides a full range of banking services to small and medium-size businesses and to professionals and the general public in Orange, Los Angeles, San Bernardino and San
Diego counties, in Southern California. Substantially all of our operations are conducted and substantially all of our assets are owned by the Bank, which accounts for substantially all of our consolidated revenues, operating income and expenses.

The following discussion presents information about our consolidated results of operations for the three and six month periods ended
June 30, 2008 and 2007 and our consolidated financial condition, liquidity and capital resources at June 30, 2008 and should be read in conjunction with our interim consolidated financial statements and the notes thereto included elsewhere
in this Report.

Forward-Looking Information

Statements contained in this Report that are not historical facts or that discuss our expectations, beliefs or views regarding our future operations or future financial performance, or financial or other trends in our
business, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can be
identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words believe, expect, anticipate, intend, plan, estimate,
project, or words of similar meaning, or future or conditional verbs such as will, would, should, could, or may. The information contained in such forward-looking statements is
based on current information and assumptions about future events over which we do not have control and our business is subject to a number of risks and uncertainties that could cause our financial condition or actual operating results in the future
to differ significantly from our expected financial condition or operating results that are set forth in those statements. Certain of those risks and uncertainties are summarized below, in this Item 2, under the caption Risks that could
Affect our Future Financial Performance and those, as well as other, risks are discussed in detail in Item 1A, Risk Factors, in our Annual Report on Form 10-K for our fiscal year ended December 31, 2007 and readers of
this Report are urged to read that summary below and the information contained in Item 1A of the 2007 Annual Report on Form 10-K in conjunction with this Report.

Due to those risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Report, which speak only as of the date of this Report, or to make
predictions about future performance based solely on historical financial performance. We also disclaim any obligation to update forward-looking statements contained in this Report or in our Annual Report on Form 10-K or any other prior filings with
Securities and Exchange Commission.



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##### Table of Contents

Overview of Operating Results in the Three and Six Months Ended June 30, 2008

The following table sets forth information regarding the interest income that we generated, the interest expense that we incurred, our
net interest income, noninterest income, noninterest expense, and our net income (loss) and net income (loss) per share for the three and six months ended June 30, 2008 and 2007.



|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|--------------------------------------------------- |  | --------------------------------------------------------- | ---------- | - | ------------------------- | - | ------------- |  | ------ | ----------- |  | ----------- | ---------- | ------------- | - | ---------- |  | ----- | --
|                                                    |  | Three Months Ended June 30,                               |            |   | Six Months Ended June 30, |  
|                                                    |  | 2008Amounts                                               |            |   | 2007Amounts               |   | PercentChange |  |        | 2008Amounts |  | 2007Amounts |            | PercentChange |  
|                                                    |  | (Unaudited) (Dollars in thousands, except per share data) |           
|Interest income                                     |  | $                                                         | 15,128     |   |                           | $ | 17,892        |  | (15.4  | )%          |  | $           | 31,032     |               | $ | 35,052     |  | (11.5 | )%
|Interest expense                                    |  |                                                           | 8,613      |   |                           |   | 10,046        |  | (14.3  | )%          |  |             | 17,632     |               |   | 19,435     |  | (9.3  | )%
|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|Net interest income                                 |  | $                                                         | 6,515      |   |                           | $ | 7,846         |  | (17.0  | )%          |  | $           | 13,400     |               | $ | 15,617     |  | (14.2 | )%
|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|Provision for loan losses                           |  | $                                                         | 2,741      |   |                           | $ | 325           |  | 743.4  | %           |  | $           | 3,816      |               | $ | 625        |  | 510.6 | % 
|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|Net interest income after provision for loan losses |  | $                                                         | 3,774      |   |                           | $ | 7,521         |  | (49.8  | )%          |  | $           | 9,584      |               | $ | 14,992     |  | (36.1 | )%
|Noninterest income                                  |  | $                                                         | 410        |   |                           | $ | 315           |  | 30.2   | %           |  | $           | 1,884      |               | $ | 668        |  | 182.0 | % 
|Noninterest expense                                 |  | $                                                         | 5,694      |   |                           | $ | 5,393         |  | 5.6    | %           |  | $           | 11,390     |               | $ | 10,493     |  | 8.5   | % 
|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|(Loss) income before income taxes                   |  | $                                                         | (1,510     | ) |                           | $ | 2,443         |  | (161.8 | )%          |  | $           | 78         |               | $ | 5,167      |  | (98.5 | )%
|                                                    |  |                                                           |            |   |                           |   |               |  |        |             |  |             |            |               |   |            |  |       |   
|Net (loss) income                                   |  | $                                                         | (830       | ) |                           | $ | 1,544         |  | (153.8 | )%          |  | $           | 170        |               | $ | 3,138      |  | (94.6 | )%
|Net income (loss) per diluted share                 |  | $                                                         | (0.08      | ) |                           | $ | 0.14          |  | (157.1 | )%          |  | $           | 0.02       |               | $ | 0.29       |  | (93.1 | )%
|Weighted average number of diluted shares           |  |                                                           | 10,478,242 |   |                           |   | 10,682,401    |  | (1.9   | )%          |  |             | 10,641,513 |               |   | 10,689,768 |  | (0.5  | )%

As the table above indicates, we incurred a net loss of $830,000, or $0.08 per diluted share, in
the three months ended June 30, 2008, as compared to net income of $1.5 million, or $0.14 per diluted share in the same three months of 2007. In the six months ended June 30, 2008, net income declined to $170,000, or $0.02 per diluted
share, from $3.1 million, or $0.29 per diluted share, in the same six months of 2007.

The net loss in this years second quarter and
the decline in net income in the first six months of 2008 were primarily attributable to:



| |  |  | Declines in interest income of $2.8 million, or 15.4%, and $4.0 million, or 11.5%, respectively, in the three and six month periods ended June 30, 2008, due
primarily to (i) reductions in interest rates by the Federal Reserve Board in response to the economic downturn, which led to decreases in prevailing interest rates that adversely affected the yields on our loans and other interest-earning
assets and (ii) to a lesser extent, increases in non-performing loans on which we ceased accruing interest income. The increase in non-performing loans was primarily attributable to three residential estate construction loans, in an aggregate
amount of $7.6 million, which had become delinquent and, as a result, were placed on nonaccrual status.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Declines in net interest income of $1.3 million, or 17%, and $2.2 million, or 14% in those same three and six month periods, respectively, due primarily to the
aforementioned decline in interest income, which was only partially offset by decreases in interest expense of $1.4 million, or 14.3%, and $1.8 million, or 9.3%, respectively. Those decreases in interest expense were primarily due to the
aforementioned decreases in prevailing market rates of interest.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in the provision for possible loan losses of $2.4 million, or approximately 740%, in the second quarter of the current year to replenish the loan loss
reserve following net loan charge-offs of $2.9 million and to provide for the increase in non-performing loans and the risk that additional loan defaults may occur due to worsening economic conditions. The increase in the provision for possible loan
losses enabled us to increase our loan loss reserve to $7.1 million, or approximately 0.89% of loans outstanding, at June 30, 2008, as compared to $6.1 million, or 0.79%, of the loans outstanding at December 31, 2007.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe that our actions in charging off delinquent loans and increasing the loan loss reserve has improved the
quality of our loan portfolio and, at the same time, enhances our ability to absorb additional loan losses that could occur during the balance of 2008 if economic conditions worsen. Additionally, as a result of actions taken in the last two years to
significantly reduce the volume of single family mortgage loans and real estate construction loans that we make, such loans represented only 7.9% and 4.9%, respectively, of our total loans that were outstanding at June 30, 2008.



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##### Table of Contents

The following table indicates the impact of the decreases in our net interest income and the declines in
earnings in the three and six months ended June 30, 2008:



|                                          |  |                            |    |  |                          |   |  |             |   |  |      |  
|----------------------------------------- |  | -------------------------- | -- |  | ------------------------ | - |  | ----------- | - |  | ---- | -
|                                          |  | Three Months EndedJune 30, |    |  | Six Months EndedJune 30, |  
|                                          |  | 2008                       |    |  | 2007                     |   |  | 2008        |   |  | 2007 |  
|                                          |  | (Unaudited)                |    |  |                          |   |  | (Unaudited) |   |  |      |  
|Net interest margin(1) (2)                |  | 2.41                       | %  |  | 2.92                     | % |  | 2.49        | % |  | 2.99 | %
|Return on average assets(1)               |  | (0.30                      | )% |  | 0.56                     | % |  | 0.03        | % |  | 0.59 | %
|Return on average shareholders equity(1) |  | (3.47                      | )% |  | 6.79                     | % |  | 0.35        | % |  | 7.01 | %



|(1) | Annualized.
|--- | -----------



|(2) | Net interest income expressed as a percentage of total average interest earning assets.
|--- | ---------------------------------------------------------------------------------------

At June 30, 2008, non-performing loans totaled $11.6 million, or 1.5% of total loans, and the ratio of the Banks total capital to
risk-weighted assets was 11.2%, which exceeded the ratio required, under bank regulatory guidelines, for the Bank to continue to be rated, for capital adequacy purposes, as a well-capitalized banking institution.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (GAAP) and general practices in the banking industry. Certain of those accounting policies are
considered critical accounting policies, because they require us to make estimates and assumptions regarding circumstances or trends that could affect the value of those assets, such as, for example, assumptions regarding economic conditions or
trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our other assets. Those estimates and assumptions are made based on current information available to us regarding those economic
conditions or trends or other circumstances. If changes were to occur in the events, trends or other circumstances on which our estimates or assumptions were based, or other unanticipated events were to happen that might affect our operating
results, under GAAP it could become necessary to reduce the carrying values of the affected assets on our balance sheet.

Our critical
accounting policies relate to the determination of our allowance for loan losses, the fair value of securities available for sale and the valuation of deferred tax assets.

Allowance for Loan Losses. The failure of borrowers to repay their loans is an inherent risk of the banking business. Therefore, like virtually
all banks and other lending institutions, we follow the practice of maintaining reserves (often referred to as an allowance) against which we charge losses on the loans we make (the allowance for loan losses). The accounting policies and
practices we follow in determining the sufficiency of that allowance require us to make judgments and assumptions about economic and market conditions and trends that can affect the ability of our borrowers to meet their loan payment obligations to
us. Accordingly, we use historical loss factors, adjusted for current economic market conditions and other economic indicators, to estimate the potential losses inherent in our loan portfolio and assess the sufficiency of our allowance for loan
losses. If unanticipated changes were to occur in those conditions or trends, such as those that occurred during the first six months of 2008, actual loan losses could be greater than those predicted by those loss factors and our prior assessments
of economic conditions and trends. In such an event, it could be necessary for us to increase the allowance for loan losses by means of a charge to income referred to in our financial statements as the provision for loan losses. Such an
increase would reduce the carrying value of the loans on our balance sheet, and the additional provision for loan losses taken to increase that allowance would reduce our income in the period when it is determined that an increase in the allowance
for loan losses is necessary. See the discussion in the subsections entitled Results of OperationsProvision for Loan Losses and Financial ConditionAllowance for Loan Losses and Nonperforming Loans below.



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##### Table of Contents

Fair Value of Securities Available for Sale. Securities available for sale are those that we
intend to hold for an indefinite period of time, but which we may sell in response to changes in liquidity needs, changes in interest rates, changes in prepayment risks or other similar factors. Such securities are recorded at fair value. Any
unrealized gains and losses are reported as Other Comprehensive Income (Loss) rather than included in or deducted from earnings. We determine the fair value of those securities (as opposed to securities which we intend to hold to
maturity) by obtaining price quotations from third party vendors and securities brokers. When such quotations are not available, a reasonable fair value is determined by using a variety of industry standard pricing methodologies including, but not
limited to, discounted cash flow analysis, matrix pricing, option adjusted spread models, as well as fundamental analysis. These pricing methodologies require us to make various assumptions relating to such matters as future prepayment speeds,
yield, duration, monetary policy and demand and supply for the individual securities. Consequently, if changes were to occur in the market or other conditions on which those assumptions were based, it could become necessary for us to make
adjustments to the fair values of those securities, which would have the effect of changing our accumulated other comprehensive gain (loss) in our consolidated statements of financial condition.

Utilization of Deferred Income Tax Benefits. The provision that we make for income taxes is based on, among other things, our ability to use
certain income tax benefits available under state and federal income tax laws to reduce our income tax liability. As of June 30, 2008, the total of the unused income tax benefits (included in Other Assets in our consolidated balance
sheet), available to reduce our income taxes in future periods was $6.7 million. Unless used, such tax benefits expire over time. Therefore, the realization of those benefits is dependent on our generating taxable income in the future in amounts
sufficient to enable us to use those tax benefits prior to their expiration. We have made a judgment, based on historical experience and current and anticipated market and economic conditions and trends, that it is more likely than not that we will
generate taxable income in future years sufficient to fully utilize those benefits before they expire. In the event that market or economic conditions or our results of operation were to change in a manner that would lead us to conclude that it
would be less likely that those benefits could be fully utilized, it could become necessary for us to establish a valuation reserve to cover any potential loss of those tax benefits by increasing the provision we make for income taxes, which would
have the effect of reducing our net income in the period when that valuation reserve is established.

Utilization of Current Income Tax
Receivable. As of June 30, 2008 we had a current net income tax receivable of $2.3 million generated by (i) a $805,000 receivable for 2007 income tax, (ii) $1.4 million of estimated overpayments of taxes for 2008, and (iii) a
$92,000 expected income tax benefit from a taxable operating loss for the first six months of 2008. We expect to utilize the $92,000 income tax benefit in 2008 or file an amended tax return for 2006.

Results of Operations

Net Interest Income

One of the principal determinants of a banks income is net interest income, which is the difference between (i) the
interest that a bank earns on loans, investment securities and other interest-earning assets, on the one hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest
that it pays on borrowings and other interest-bearing liabilities, on the other hand. As a general rule, all other things being equal, the greater the difference between the amount of our interest income and the amount of our interest expense, the
greater will be our income; whereas, a decline in that difference will generally result in a decline in our net income. A banks interest income and interest expense are, in turn, affected by a number of factors, some of which are outside of
its control, including national and local economic conditions and the monetary policies of the Federal Reserve Board which affect interest rates, the demand for loans, and the ability of borrowers to meet their loan payment obligations. Net interest
income, when expressed as a percentage of total average interest earning assets, is a banking organizations net interest margin.



17



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##### Table of Contents

The following table sets forth our interest income, interest expense and net interest income (in
thousands of dollars) and our net interest margin in the three and six months ended June 30, 2008 and 2007, respectively:



|                    |  |                            |        |   |                          |   |        |               |  |       |            |  |   |            |   |  |               |        |   |  |       |   
|------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ------------- |  | ----- | ---------- |  | - | ---------- | - |  | ------------- | ------ | - |  | ----- | --
|                    |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                    |  | 2008Amount                 |        |   | 2007Amount               |   |        | PercentChange |  |       | 2008Amount |  |   | 2007Amount |   |  | PercentChange |       
|                    |  | (Unaudited)                |        |   | (Unaudited)              |  
|Interest income     |  | $                          | 15,128 |   |                          | $ | 17,892 |               |  | (15.4 | )%         |  | $ | 31,032     |   |  | $             | 35,052 |   |  | (11.5 | )%
|Interest expense    |  |                            | 8,613  |   |                          |   | 10,046 |               |  | (14.3 | )%         |  |   | 17,632     |   |  |               | 19,435 |   |  | (9.3  | )%
|                    |  |                            |        |   |                          |   |        |               |  |       |            |  |   |            |   |  |               |        |   |  |       |   
|Net interest income |  | $                          | 6,515  |   |                          | $ | 7,846  |               |  | (17.0 | )%         |  | $ | 13,400     |   |  | $             | 15,617 |   |  | (14.2 | )%
|                    |  |                            |        |   |                          |   |        |               |  |       |            |  |   |            |   |  |               |        |   |  |       |   
|Net interest margin |  |                            | 2.41   | % |                          |   | 2.92   | %             |  |       |            |  |   | 2.49       | % |  |               | 2.99   | % |  |       |   

As the table above indicates, our net interest income decreased by $1.3 million, or 17%, in
the second quarter of 2008, and by $2.2 million, or 14%, in the six months ended June 30, 2008, as compared to the same respective periods of 2007. Those decreases were primarily attributable to decreases in interest income of $2.8 million, or
15%, and $4.0 million, or 12%, respectively, in the three and six month periods of 2008. Those decreases in interest income more than offset decreases in interest expense of $1.4 million, or 14%, and $1.8 million, or 9%, respectively, in the
three and six month periods ended June 30, 2008 over the respective corresponding periods of 2007.

The decreases in interest income
in the three and six months ended June 30, 2008, were due primarily (i) to a 325 basis points decline in prevailing market rates of interest primarily as a result of reductions, commenced in September 2007, in the federal funds rate
implemented by the Federal Reserve Board in response to the economic downturn, and (ii) to a lesser extent, increases in non-performing loans on which we ceased accruing interest income. Those decreases were partially offset by the effects on
interest income of increases, in the three and six months ended June 30, 2008, of $47 million and $51 million, respectively, in average loans outstanding, which generate higher yields than other earning assets. We used lower-yielding federal
funds and proceeds from the sale of securities available for sale to fund those increases in loans.

The decreases in interest expense
during the three and six month period ended June 30, 2008 were primarily attributable to the aforementioned decreases in prevailing market rates of interest, which enabled us to reduce interest rates on interest bearing deposits, partially
offset by increases in the volume of interest-bearing deposits.

Due primarily to the decline in prevailing market rates of interest, our
net interest margin decreased by 51 basis points to 2.41% in the three months ended June 30, 2008, from 2.92% in the same period of 2007, and by 50 basis points to 2.49% in the six months ended June 30, 2008, from 2.99% in the
same six months ended June 30, 2007. In the three months ended June 30, 2008, the yield on interest-earning assets declined to 5.60% from 6.66% in the same period of 2007, which more than offset a decline in the average interest rate paid
on interest bearing liabilities to 4.09%, from 4.82% in the same three month period of 2007. Similarly, in the six months ended June 30, 2008, the average rate of interest earned on average earning assets decreased to 5.79%, from 6.71% in the
same six month period of 2007, and was only partially offset by a decrease in the average interest rate paid on interest bearing deposits to 4.24%, from 4.82% in the same period of 2007. The decreases in net interest margin also reflect timing
differences in the impact that the declines in market rates of interest have on our interest income and interest expense. Those declines resulted in automatic decreases in the interest rates on our adjustable rate loans, whereas the impact of those
declines on the interest we paid on deposits has been more gradual primarily as a result of the maturity schedule of our time certificates of deposit.



18



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##### Table of Contents

Average Balances

Information Regarding Average Assets and Average Liabilities

The following table sets forth
information regarding our average balance sheet, yields on interest earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the three months ended June 30, 2008 and 2007.



|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|------------------------------------------ |  | --------------------------- | --------- | ------------------- | ---- | ----------------- |  | ---- | -------------- |  | ------------------- | --------- | ----------------- | - | ------ |  | ---- | -
|                                           |  | Three Months Ended June 30, |          
|                                           |  | 2008                        |           |                     | 2007 |                  
|                                           |  | AverageBalance              |           | InterestEarned/Paid |      | AverageYield/Rate |  |      | AverageBalance |  | InterestEarned/Paid |           | AverageYield/Rate |  
|                                           |  | (Dollars in thousands)      |          
|                                           |  | (Unaudited)                 |          
|Interest earning assets:                   |  |                             |           |                    
|Short-term investments(1)                  |  | $                           | 68,062    |                     | $    | 339               |  | 2.01 | %              |  | $                   | 92,404    |                   | $ | 1,184  |  | 5.14 | %
|Securities available for sale and stock(2) |  |                             | 229,348   |                     |      | 2,549             |  | 4.47 | %              |  |                     | 243,942   |                   |   | 2,751  |  | 4.52 | %
|Loans                                      |  |                             | 788,545   |                     |      | 12,240            |  | 6.24 | %              |  |                     | 741,643   |                   |   | 13,957 |  | 7.55 | %
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total earning assets                       |  |                             | 1,085,955 |                     |      | 15,128            |  | 5.60 | %              |  |                     | 1,077,989 |                   |   | 17,892 |  | 6.66 | %
|Noninterest earning assets                 |  |                             | 38,383    |                     |      |                   |  |      |                |  |                     | 28,329    |                   |   |        |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Assets                               |  | $                           | 1,124,338 |                     |      |                   |  |      |                |  | $                   | 1,106,318 |                   |   |        |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest-bearing liabilities:              |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest-bearing checking accounts         |  | $                           | 19,233    |                     |      | 24                |  | 0.50 | %              |  | $                   | 22,509    |                   |   | 42     |  | 0.75 | %
|Money market and savings accounts          |  |                             | 142,691   |                     |      | 695               |  | 1.96 | %              |  |                     | 150,842   |                   |   | 1,340  |  | 3.56 | %
|Certificates of deposit                    |  |                             | 434,865   |                     |      | 5,073             |  | 4.69 | %              |  |                     | 399,628   |                   |   | 5,167  |  | 5.19 | %
|Other borrowings                           |  |                             | 232,538   |                     |      | 2,581             |  | 4.46 | %              |  |                     | 234,914   |                   |   | 2,914  |  | 4.98 | %
|Junior subordinated debentures             |  |                             | 17,682    |                     |      | 240               |  | 5.48 | %              |  |                     | 27,837    |                   |   | 584    |  | 8.41 | %
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total interest-bearing liabilities         |  |                             | 847,009   |                     |      | 8,613             |  | 4.09 | %              |  |                     | 835,730   |                   |   | 10,047 |  | 4.82 | %
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Noninterest-bearing liabilities            |  |                             | 181,394   |                     |      |                   |  |      |                |  |                     | 179,380   |                   |   |        |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Liabilities                          |  |                             | 1,028,403 |                     |      |                   |  |      |                |  |                     | 1,015,110 |                   |   |        |  |      |  
|Shareholders equity                       |  |                             | 95,935    |                     |      |                   |  |      |                |  |                     | 91,208    |                   |   |        |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Liabilities and Shareholders Equity |  | $                           | 1,124,338 |                     |      |                   |  |      |                |  | $                   | 1,106,318 |                   |   |        |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Net interest income                        |  |                             |           |                     | $    | 6,515             |  |      |                |  |                     |           |                   | $ | 7,845  |  |      |  
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest rate spread                       |  |                             |           |                     |      |                   |  | 1.51 | %              |  |                     |           |                   |   |        |  | 1.84 | %
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Net interest margin                        |  |                             |           |                     |      |                   |  | 2.41 | %              |  |                     |           |                   |   |        |  | 2.92 | %
|                                           |  |                             |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------



|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



19



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##### Table of Contents

The following table sets forth information regarding our average balance sheet, yields on interest
earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the six months ended June 30, 2008 and 2007.



|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|------------------------------------------ |  | ------------------------- | --------- | ------------------- | ---- | ----------------- |  | ---- | -------------- |  | ------------------- | --------- | ----------------- | - | ------ |  | ---- | -
|                                           |  | Six Months Ended June 30, |          
|                                           |  | 2008                      |           |                     | 2007 |                  
|                                           |  | AverageBalance            |           | InterestEarned/Paid |      | AverageYield/Rate |  |      | AverageBalance |  | InterestEarned/Paid |           | AverageYield/Rate |  
|                                           |  | (Dollars in thousands)    |          
|                                           |  | (Unaudited)               |          
|Interest earning assets:                   |  |                           |           |                    
|Short-term investments(1)                  |  | $                         | 52,672    |                     | $    | 624               |  | 2.38 | %              |  | $                   | 68,219    |                   | $ | 1,758  |  | 5.20 | %
|Securities available for sale and stock(2) |  |                           | 236,033   |                     |      | 5,282             |  | 4.50 | %              |  |                     | 246,928   |                   |   | 5,624  |  | 4.59 | %
|Loans                                      |  |                           | 788,546   |                     |      | 25,126            |  | 6.41 | %              |  |                     | 737,703   |                   |   | 27,670 |  | 7.56 | %
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total earning assets                       |  |                           | 1,077,251 |                     |      | 31,032            |  | 5.79 | %              |  |                     | 1,052,850 |                   |   | 35,052 |  | 6.71 | %
|Noninterest earning assets                 |  |                           | 31,652    |                     |      |                   |  |      |                |  |                     | 28,154    |                   |   |        |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Assets                               |  | $                         | 1,108,903 |                     |      |                   |  |      |                |  | $                   | 1,081,004 |                   |   |        |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest-bearing liabilities:              |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest-bearing checking accounts         |  | $                         | 19,280    |                     |      | 54                |  | 0.56 | %              |  | $                   | 22,133    |                   |   | 81     |  | 0.74 | %
|Money market and savings accounts          |  |                           | 151,938   |                     |      | 1,719             |  | 2.28 | %              |  |                     | 144,078   |                   |   | 2,503  |  | 3.50 | %
|Certificates of deposit                    |  |                           | 422,347   |                     |      | 10,178            |  | 4.85 | %              |  |                     | 392,668   |                   |   | 10,052 |  | 5.16 | %
|Other borrowings                           |  |                           | 224,437   |                     |      | 5,134             |  | 4.60 | %              |  |                     | 227,131   |                   |   | 5,627  |  | 5.00 | %
|Junior subordinated debentures             |  |                           | 17,682    |                     |      | 547               |  | 6.22 | %              |  |                     | 27,837    |                   |   | 1,172  |  | 8.49 | %
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total interest-bearing liabilities         |  |                           | 835,684   |                     |      | 17,632            |  | 4.24 | %              |  |                     | 813,847   |                   |   | 19,435 |  | 4.82 | %
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Noninterest-bearing liabilities            |  |                           | 176,698   |                     |      |                   |  |      |                |  |                     | 176,827   |                   |   |        |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Liabilities                          |  |                           | 1,012,382 |                     |      |                   |  |      |                |  |                     | 990,674   |                   |   |        |  |      |  
|Shareholders equity                       |  |                           | 96,521    |                     |      |                   |  |      |                |  |                     | 90,330    |                   |   |        |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Total Liabilities and Shareholders Equity |  | $                         | 1,108,903 |                     |      |                   |  |      |                |  | $                   | 1,081,004 |                   |   |        |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Net interest income                        |  |                           |           |                     | $    | 13,400            |  |      |                |  |                     |           |                   | $ | 15,617 |  |      |  
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Interest rate spread                       |  |                           |           |                     |      |                   |  | 1.55 | %              |  |                     |           |                   |   |        |  | 1.89 | %
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  
|Net interest margin                        |  |                           |           |                     |      |                   |  | 2.49 | %              |  |                     |           |                   |   |        |  | 2.99 | %
|                                           |  |                           |           |                     |      |                   |  |      |                |  |                     |           |                   |   |        |  |      |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------



|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



20



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##### Table of Contents

The following table sets forth the changes in interest income, including loan fees, and interest paid in
the three and six month periods ended June 30, 2008, as compared to the same periods in 2007, and the extent to which those changes were attributable to changes in the volume of and rates of interest earned on interest-earning assets and the
volume of and interest paid on interest-bearing liabilities.



|                                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|--------------------------------------- |  | ------------------------------------------------------------------ | ---- | - | ---------------------------------------------------------------- | - | ------ | ----- |  | - | --------- | - |  | ------- | ----- | - | ----- | - | ------ | - |  | - | ------ | -
|                                        |  | Three Months Ended June 30,2008 vs 2007Increase (decrease) due to: |      |   | Six Months Ended June 30,2008 vs 2007Increase (decrease) due to: |  
|                                        |  | Volume(1)                                                          |      |   | Rate(1)                                                          |   |        | Total |  |   | Volume(1) |   |  | Rate(1) |       |   | Total |  
|                                        |  | (Unaudited)                                                        |      |   | (Unaudited)                                                      |  
|                                        |  | (Dollars in thousands)                                             |      |   | (Dollars in thousands)                                           |  
|Interest income:                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|Short-term investments(2)               |  | $                                                                  | (255 | ) |                                                                  | $ | (589   | )     |  | $ | (844      | ) |  | $       | (336  | ) |       | $ | (798   | ) |  | $ | (1,134 | )
|Securities available for sale and stock |  |                                                                    | (169 | ) |                                                                  |   | (33    | )     |  |   | (202      | ) |  |         | (235  | ) |       |   | (107   | ) |  |   | (342   | )
|Loans                                   |  |                                                                    | 829  |   |                                                                  |   | (2,547 | )     |  |   | (1,718    | ) |  |         | 1,845 |   |       |   | (4,389 | ) |  |   | (2,544 | )
|                                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|Total earning assets                    |  |                                                                    | 405  |   |                                                                  |   | (3,169 | )     |  |   | (2,764    | ) |  |         | 1,274 |   |       |   | (5,294 | ) |  |   | (4,020 | )
|Interest expense:                       |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|Interest-bearing checking accounts      |  |                                                                    | (6   | ) |                                                                  |   | (12    | )     |  |   | (18       | ) |  |         | (10   | ) |       |   | (17    | ) |  |   | (27    | )
|Money market and savings accounts       |  |                                                                    | (69  | ) |                                                                  |   | (576   | )     |  |   | (645      | ) |  |         | 131   |   |       |   | (915   | ) |  |   | (784   | )
|Certificates of deposit                 |  |                                                                    | 426  |   |                                                                  |   | (520   | )     |  |   | (94       | ) |  |         | 752   |   |       |   | (626   | ) |  |   | 126    |  
|Borrowings                              |  |                                                                    | (30  | ) |                                                                  |   | (303   | )     |  |   | (333      | ) |  |         | (64   | ) |       |   | (429   | ) |  |   | (493   | )
|Junior subordinated debentures          |  |                                                                    | (175 | ) |                                                                  |   | (168   | )     |  |   | (343      | ) |  |         | (361  | ) |       |   | (264   | ) |  |   | (625   | )
|                                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|Total interest-bearing liabilities      |  |                                                                    | 146  |   |                                                                  |   | (1,579 | )     |  |   | (1,433    | ) |  |         | 448   |   |       |   | (2,251 | ) |  |   | (1,803 | )
|                                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  
|Net interest income                     |  | $                                                                  | 259  |   |                                                                  | $ | (1,590 | )     |  | $ | (1,331    | ) |  | $       | 826   |   |       | $ | (3,043 | ) |  | $ | (2,217 | )
|                                        |  |                                                                    |      |   |                                                                  |   |        |       |  |   |           |   |  |         |       |   |       |   |        |   |  |   |        |  



|(1) | Changes in interest earned and interest paid due to changes in the mix of interest-earning assets and interest-bearing
liabilities have been allocated to the change due to volume and the change due to interest rates in proportion to the relationship of the absolute dollar amounts of the changes in each.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

The above table indicates that the decrease of $1.3 million in our net interest income in the three months ended
June 30, 2008, as compared to the like period in 2007, was primarily the result of a $1.6 million decrease in rate variance, which more than offset an increase of $259,000 in volume variance. The increase in volume variance reflects the
increases in average interest earning assets of $8 million and interest bearing liabilities of $11 million, while the decline in rate variance was a result of a decrease in interest rates on average earning assets of 106 basis points and a decrease
of 73 basis points in interest rates paid on interest bearing liabilities.

The decline of $2.2 million in net interest income in the six
months ended June 30, 2008, as compared to the same six months of 2007, was due to an decrease in interest income that was attributable to a decline in interest rates earned. Those decreases were offset, somewhat, by decreases in the interest
rates paid on interest-bearing assets. The decrease in rate variance in the six months ended June 30, 2008 reflects a decrease in interest rates earned on average interest-earning assets of 92 basis points, somewhat offset by a decrease in
interest rates paid on average interest-earning liabilities of 58 basis points, in the six months ended June 30, 2008, as compared to the same period of 2007.

Provision for Loan Losses

The failure of borrowers to repay their loans is an inherent risk
of the banking business. Therefore, like virtually all banks and other lending institutions, we follow the practice of maintaining an allowance for possible loan losses that occur from time to time as an incidental part of the banking business. When
it is determined that the payment in full of a loan has become unlikely, the carrying value of the loan is reduced to what management believes is its realizable value. This reduction, which is referred to as a loan charge-off, or
write-down is charged against that allowance.



21



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##### Table of Contents

The amount of the allowance for loan losses is increased periodically (i) to replenish the allowance after it has been reduced due to loan charge-offs,
(ii) to reflect changes in the volume of outstanding loans, and (iii) to take account of changes in the risk of potential losses due to a deterioration in the condition of borrowers or in the value of property securing nonperforming
loans or adverse changes in economic conditions. See Financial ConditionAllowance for Loan Losses and Nonperforming Loans below in this Section of this Report. Increases in the allowance are made through a charge, recorded as
an expense in the statement of operations, referred to as the provision for loan losses. Recoveries of loans previously charged-off are added back to the allowance and, therefore, have the effect of increasing the allowance and reducing
the amount of the provision that might otherwise have had to be made to replenish or increase the allowance.

During the second quarter of
2008, we made provisions of $2.7 million for potential loan losses, as compared to $325,000 in the same quarter of 2007, in response to: (i) second quarter loan charge-offs of $2.3 million, as compared to charge-offs of $117,000 in the
same quarter of the prior year, which caused us to make additional provisions to replenish the allowance for loan losses; and (ii) continued economic weakness which increased the risks of future loan defaults by borrowers. As of June 30,
2008, nonaccrual loans increased to $11.6 million from $4.6 million at June 30, 2007.

As a result of the provisions made in this
years second quarter, the allowance for loan losses totaled $7.1 million, or 0.89% of loans outstanding, as of June 30, 2008, as compared to $6.1 million, or 0.79% of loans outstanding, at December 31, 2007.

We employ economic models that are based on bank regulatory guidelines, industry standards and historical loss experience to evaluate and determine both
the sufficiency of the allowance for loan losses and the amount of the provisions that are required to be made for potential loan losses. Those determinations involve judgments about trends in current economic conditions and other events that can
affect the ability of borrowers to meet their loan obligations to us. The duration and effects of current economic trends, such as the current economic downturn, are subject to a number of risks and uncertainties and changes that are outside of our
ability to control. See the discussion below in this section under the caption Risks That Could Affect Our Future Financial PerformanceWe could incur losses on the loans we make. If changes in economic or market conditions
or unexpected subsequent events were to occur, it could become necessary for us to incur additional charges to increase the allowance for loan losses, which would have the effect of reducing our income.

In addition, the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions, as an integral part of their examination
processes, periodically review the adequacy of our allowance for loan losses. These agencies may require us to make additional provisions, over and above the provisions that we have already made, the effect of which would be to reduce our income.

Noninterest Income

Noninterest income consists primarily of fees charged for services provided by the Bank on deposit account transactions and gains on sales assets. The following table identifies the components (in thousands of dollars) of, and sets forth
the percentage changes in, noninterest income in the three and six months ended June 30, 2008, as compared to the same respective periods of 2007.



|                                                    |  |                             |     |                               |                           |   |           |      |                               |    |      |   |       |   |  |   |     |  |       |  
|--------------------------------------------------- |  | --------------------------- | --- | ----------------------------- | ------------------------- | - | --------- | ---- | ----------------------------- | -- | ---- | - | ----- | - |  | - | --- |  | ----- | -
|                                                    |  | Three Months Ended June 30, |     |                               | Six Months Ended June 30, |  
|                                                    |  | Amount                      |     | PercentageChange2008 vs. 2007 |                           |   | Amount    |      | PercentageChange2008 vs. 2007 |   
|                                                    |  | 2008                        |     |                               | 2007                      |   |           | 2008 |                               |    | 2007 |  
|                                                    |  | Unaudited                   |     |                               |                           |   | Unaudited |      |                               |   
|Service fees on deposits                            |  | $                           | 285 |                               |                           | $ | 198       |      | 43.9                          | %  |      | $ | 497   |   |  | $ | 385 |  | 29.1  | %
|Net gains on sales of securities available for sale |  |                             | 52  |                               |                           |   |          |      | N/M                           |    |      |   | 1,132 |   |  |   |    |  | N/M   |  
|Gain (loss) on sale of other real estate owned      |  |                             | (40 | )                             |                           |   |          |      | N/M                           |    |      |   | (40   | ) |  |   |    |  | N/M   |  
|Other                                               |  |                             | 113 |                               |                           |   | 117       |      | (3.4                          | )% |      |   | 295   |   |  |   | 283 |  | 4.2   | %
|                                                    |  |                             |     |                               |                           |   |           |      |                               |    |      |   |       |   |  |   |     |  |       |  
|Total                                               |  | $                           | 410 |                               |                           | $ | 315       |      | 30.2                          | %  |      | $ | 1,884 |   |  | $ | 668 |  | 182.0 | %
|                                                    |  |                             |     |                               |                           |   |           |      |                               |    |      |   |       |   |  |   |     |  |       |  

The increase in non-interest income for the three months ended June 30, 2008, as compared to
the same period



22



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##### Table of Contents

in 2007, was primarily the result of an $87,000 increase in service fees on deposit account transactions. The increase in non-interest income for the six
months ended June 30, 2008, as compared to the same period in 2007, was primarily the result of (i) a $1.1 million gain recognized, during the first quarter of 2008, on sales of securities available for sale, which were made to the
reposition our portfolio of such securities as part of our overall management of the mix and matching of maturities and repricing of our assets and liabilities, and (ii) a $112,000 increase in fees on deposit account transactions.

Noninterest Expense

The
following table compares the amounts (in thousands of dollars) of the principal components of noninterest expense in the three and six months ended June 30, 2008 and in the same three and six month periods of 2007.



|                                |  |                                  |       |                               |                                  |       |        |       |                               |  |   |        |  |   |        |  |       |   
|------------------------------- |  | -------------------------------- | ----- | ----------------------------- | -------------------------------- | ----- | ------ | ----- | ----------------------------- |  | - | ------ |  | - | ------ |  | ----- | --
|                                |  | Three Months Ended June 30,      |       |                               | Six Months Ended June 30,        |      
|                                |  | Amount                           |       | PercentageChange2008 vs. 2007 |                                  |       | Amount |       | PercentageChange2008 vs. 2007 | 
|                                |  | 2008                             |       | 2007                          |                                  |       | 2008   |       | 2007                          | 
|                                |  | Unaudited (Dollars in thousands) |       |                               | Unaudited (Dollars in thousands) |      
|Salaries and employee benefits  |  | $                                | 2,832 |                               | $                                | 2,794 |        | 1.4   | %                             |  | $ | 6,122  |  | $ | 5,775  |  | 6.0   | % 
|Occupancy                       |  |                                  | 697   |                               |                                  | 700   |        | (0.4  | )%                            |  |   | 1,379  |  |   | 1,365  |  | 1.0   | % 
|Equipment and depreciation      |  |                                  | 282   |                               |                                  | 323   |        | (12.7 | )%                            |  |   | 566    |  |   | 641    |  | (11.7 | )%
|Data processing                 |  |                                  | 177   |                               |                                  | 158   |        | 12.0  | %                             |  |   | 350    |  |   | 324    |  | 8.0   | % 
|Professional fees               |  |                                  | 308   |                               |                                  | 225   |        | 36.9  | %                             |  |   | 581    |  |   | 400    |  | 45.3  | % 
|Customer expense                |  |                                  | 134   |                               |                                  | 186   |        | (28.0 | )%                            |  |   | 248    |  |   | 345    |  | (28.1 | )%
|FDIC insurance                  |  |                                  | 145   |                               |                                  | 199   |        | (27.1 | )%                            |  |   | 268    |  |   | 199    |  | 34.7  | % 
|Other real estate owned expense |  |                                  | 348   |                               |                                  |      |        | N/M   |                               |  |   | 429    |  |   |       |  | N/M   |   
|Other operating expense(1)      |  |                                  | 771   |                               |                                  | 808   |        | (4.6  | )%                            |  |   | 1,447  |  |   | 1,444  |  | 0.2   | % 
|                                |  |                                  |       |                               |                                  |       |        |       |                               |  |   |        |  |   |        |  |       |   
|Total                           |  | $                                | 5,694 |                               | $                                | 5,393 |        | 5.6   | %                             |  | $ | 11,390 |  | $ | 10,493 |  | 8.5   | % 
|                                |  |                                  |       |                               |                                  |       |        |       |                               |  |   |        |  |   |        |  |       |   



|(1) | Other operating expenses primarily consist of telephone, stationery and office supplies, regulatory, and investor
relations expenses, and insurance premiums, postage, and correspondent bank fees.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The increases in non-interest expense
in the three and six months ended June 30, 2008 were, for the most part, attributable to (i) increases of $38,000, or 1.4%, and $347,000, or 6.0%, respectively, in compensation expense, due primarily to the addition of commercial loan
officers during 2007, as part of our initiative to increase commercial loans and decrease single family real estate and real estate construction loans; (ii) increases of $83,000 and $181,000, respectively, in professional fees, and
(iii) the recognition of $348,000 and $429,000, respectively, of expenses associated with acquisition and preparation for sale of other real estate owned.

Due primarily to the decline in net interest income and, to a lesser extent, the increase in non-interest expense our efficiency ratios (non-interest expense as a percentage of total revenues) for the three and six
months ended June 30, 2008 were 82% and 75%, respectively, as compared to 66% and 64%, respectively, in the three and six months ended June 30, 2007.

Asset/Liability Management

The primary objective of asset/liability management is to reduce our exposure to interest rate
fluctuations, which can affect our net interest margins and, therefore, our net interest income and net earnings. We seek to achieve this objective by matching interest rate sensitive assets and liabilities, and maintaining the maturities and the
repricing of these assets and liabilities at appropriate levels in response to the changes in the interest rate environment. Generally, if rate sensitive assets exceed rate sensitive liabilities, net interest income will be positively impacted
during a rising interest rate environment and negatively impacted during a declining interest rate environment. When rate sensitive



23



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liabilities exceed rate sensitive assets, net interest income generally will be positively impacted during a declining interest rate environment and
negatively impacted during a rising interest rate environment. However, interest rates for different asset and liability products offered by depository institutions respond differently to changes in the interest rate environment, the relationship or
gap between interest sensitive assets and interest sensitive liabilities is only a general indicator of interest rate sensitivity and how our net interest income might be affected by changing rates of interest.

For example, rates on certain assets or liabilities typically lag behind changes in market rates of interest. Additionally, prepayments of loans and
securities available for sale, and early withdrawals of certificates of deposit, can cause the interest sensitivities to vary.

The table
below sets forth information concerning our rate sensitive assets and liabilities at June 30, 2008. The assets and liabilities are classified by the earlier of maturity or repricing dates in accordance with their contractual terms. As described
above, certain shortcomings are inherent in the method of analysis presented in this table.



|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|---------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | --------------------------- | - | -------- | ----------------------------- |  | - | ------------- | - |  | -------------------- | ------- | - | ----- | - | -------- | - |  | - | ---------
|                                                                             |  | SixMonths orLess                 |         |   | Over SixThroughTwelveMonths |   |          | Over OneYearThroughFive Years |  |   | OverFiveYears |   |  | Non-Interest-Bearing |         |   | Total
|                                                                             |  | Unaudited (Dollars in thousands)
|Assets                                                                       |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Interest-bearing deposits in other financial institutions                    |  | $                                |        |   |                             | $ | 198      |                               |  | $ |              |   |  | $                    |        |   |       | $ |         |   |  | $ | 198      
|Investment in unconsolidated trust subsidiaries                              |  |                                  |        |   |                             |   |         |                               |  |   |              |   |  |                      | 682     |   |       |   |         |   |  |   | 682      
|Securities available for sale                                                |  |                                  | 15,832  |   |                             |   | 30,327   |                               |  |   | 98,000        |   |  |                      | 85,986  |   |       |   |         |   |  |   | 230,145  
|Federal Reserve Bank and Federal Home Loan Bank stock                        |  |                                  | 13,135  |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 13,135   
|Federal funds sold                                                           |  |                                  | 50,105  |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 50,105   
|Loans, gross                                                                 |  |                                  | 366,870 |   |                             |   | 118,480  |                               |  |   | 242,292       |   |  |                      | 68,961  |   |       |   |         |   |  |   | 796,603  
|Non-interest earning assets, net                                             |  |                                  |        |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 31,829   |   |  |   | 31,829   
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Total assets                                                                 |  | $                                | 445,942 |   |                             | $ | 149,005  |                               |  | $ | 340,292       |   |  | $                    | 155,629 |   |       | $ | 31,829   |   |  | $ | 1,122,697
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Liabilities and Shareholders Equity                                          |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Noninterest-bearing deposits                                                 |  | $                                |        |   |                             | $ |         |                               |  | $ |              |   |  | $                    |        |   |       | $ | 163,117  |   |  | $ | 163,117  
|Interest-bearing deposits(1) (2)                                             |  |                                  | 291,230 |   |                             |   | 218,848  |                               |  |   | 87,344        |   |  |                      |        |   |       |   |         |   |  |   | 597,422  
|Borrowings                                                                   |  |                                  | 31,718  |   |                             |   | 78,000   |                               |  |   | 135,000       |   |  |                      |        |   |       |   |         |   |  |   | 244,718  
|Junior subordinated debentures                                               |  |                                  | 17,527  |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 17,527   
|Other liabilities                                                            |  |                                  |        |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 6,755    |   |  |   | 6,755    
|Shareholders equity                                                         |  |                                  |        |   |                             |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 93,158   |   |  |   | 93,158   
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Total liabilities and shareholders equity                                    |  | $                                | 340,475 |   |                             | $ | 296,848  |                               |  | $ | 222,344       |   |  | $                    |        |   |       | $ | 263,030  |   |  | $ | 1,122,697
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Interest rate sensitivity gap                                                |  | $                                | 105,467 |   |                             | $ | (147,843 | )                             |  | $ | 117,948       |   |  | $                    | 155,629 |   |       | $ | (231,201 | ) |  | $ |         
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative interest rate sensitivity gap                                     |  | $                                | 105,467 |   |                             | $ | (42,376  | )                             |  | $ | 75,572        |   |  | $                    | 231,201 |   |       | $ |         |   |  | $ |         
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative % of rate sensitive assets in maturity period                     |  |                                  | 40      | % |                             |   | 53       | %                             |  |   | 83            | % |  |                      | 97      | % |       |   | 100      | % |  |   |          
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Rate sensitive assets to rate sensitive liabilities and shareholders equity |  |                                  | 131     | % |                             |   | 50       | %                             |  |   | 153           | % |  |                      | N/A     |   |       |   | 12       | % |  |   |          
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative ratio                                                             |  |                                  | 131     | % |                             |   | 93       | %                             |  |   | 109           | % |  |                      | 127     | % |       |   | 100      | % |  |   |          
|                                                                             |  |                                  |         |   |                             |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          



|(1) | Excludes Bancorps savings accounts totaling $21.7 million maturing within six months of June 30, 2008.
|--- | -------------------------------------------------------------------------------------------------------



|(2) | Excludes Bancorps certificate of deposit in the amount of $250,000, which matures over 6 months and within
12 months of June 30, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



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At June 30, 2008, our rate sensitive balance sheet was shown to be in a negative twelve-month gap
position. This would imply that our net interest margin would decrease in the shortterm if interest rates were to rise and would increase in the short-term if interest rates were to fall. However, as noted above, the extent to which our net
interest margin will be impacted by changes in prevailing interests rates will depend on a number of factors, including how quickly rate sensitive assets and liabilities react to interest rate changes, the mix of our interest earning assets (loans
versus other lower yielding interest earning assets, such as securities or federal funds sold) and the mix of our interest bearing deposits (between, for example, lower interest core deposits and higher cost time certificates of deposit) and our
other interest bearing liabilities.

Financial Condition

Assets

Our total consolidated assets increased by $46 million to $1.123 billion at
June 30, 2008 from $1.077 billion at December 31, 2007, as we used increases in deposits and borrowings during the six months ended June 30, 2008 to fund increases in loans and federal funds sold.

The following table sets forth the composition of our interest earning assets (in thousands of dollars) at:



|                                                               |  |               |         |                   |   |        
|-------------------------------------------------------------- |  | ------------- | ------- | ----------------- | - | -------
|                                                               |  | June 30, 2008 |         | December 31, 2007
|                                                               |  | Unaudited    
|Federal funds sold                                             |  | $             | 50,105  |                   | $ | 39,400 
|Interest-bearing deposits with financial institutions          |  |               | 198     |                   |   | 198    
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost |  |               | 13,135  |                   |   | 12,662 
|Securities available for sale, at fair value                   |  |               | 230,145 |                   |   | 218,838
|Loans (net of allowances of $7,073 and $6,126, respectively)   |  |               | 789,530 |                   |   | 773,071

Loans

The following table sets forth, in thousands of dollars, the composition, by loan category, of our loan portfolio, at June 30, 2008 and December 31, 2007:



|                                              |  |               |         |   |                   |       |   |        |   |         |         |  |       |  
|--------------------------------------------- |  | ------------- | ------- | - | ----------------- | ----- | - | ------ | - | ------- | ------- |  | ----- | -
|                                              |  | June 30, 2008 |         |   | December 31, 2007 |      
|                                              |  | Amount        |         |   | Percent           |       |   | Amount |   |         | Percent | 
|                                              |  | Unaudited     |        
|Commercial loans                              |  | $             | 271,795 |   |                   | 34.1  | % |        | $ | 269,887 |         |  | 34.6  | %
|Commercial real estate loans - owner occupied |  |               | 175,728 |   |                   | 22.0  | % |        |   | 163,949 |         |  | 21.0  | %
|Commercial real estate loans - all other      |  |               | 117,778 |   |                   | 14.8  | % |        |   | 108,866 |         |  | 14.0  | %
|Residential mortgage loans - single family    |  |               | 62,565  |   |                   | 7.9   | % |        |   | 64,718  |         |  | 8.3   | %
|Residential mortgage loans - multi-family     |  |               | 93,709  |   |                   | 11.8  | % |        |   | 92,440  |         |  | 11.9  | %
|Construction loans                            |  |               | 39,251  |   |                   | 4.9   | % |        |   | 47,179  |         |  | 6.1   | %
|Land development loans                        |  |               | 28,265  |   |                   | 3.5   | % |        |   | 25,800  |         |  | 3.3   | %
|Consumer loans                                |  |               | 7,707   |   |                   | 1.0   | % |        |   | 6,456   |         |  | 0.8   | %
|                                              |  |               |         |   |                   |       |   |        |   |         |         |  |       |  
|Gross loans                                   |  |               | 796,798 |   |                   | 100.0 | % |        |   | 779,295 |         |  | 100.0 | %
|                                              |  |               |         |   |                   |       |   |        |   |         |         |  |       |  
|Deferred fee (income) costs, net              |  |               | (195    | ) |                   |       |   |        |   | (98     | )       |  |       |  
|Allowance for loan losses                     |  |               | (7,073  | ) |                   |       |   |        |   | (6,126  | )       |  |       |  
|                                              |  |               |         |   |                   |       |   |        |   |         |         |  |       |  
|Loans, net                                    |  | $             | 789,530 |   |                   |       |   |        | $ | 773,071 |         |  |       |  
|                                              |  |               |         |   |                   |       |   |        |   |         |         |  |       |  

Commercial loans are loans to businesses to finance capital purchases or improvements, or to
provide cash flow for operations. Commercial real estate and residential mortgage loans are loans secured by trust deeds on real property, including commercial property and single family and multi-family residences. Construction and land development
loans are interim loans to finance specific construction projects. Consumer loans include installment loans to consumers.



25



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The following table sets forth, in thousands of dollars, the maturity distribution of our loan portfolio
(excluding consumer and residential mortgage loans) at June 30, 2008:



|                                      |  |                 |         |                               |   |                |  |       |         |  |   |        
|------------------------------------- |  | --------------- | ------- | ----------------------------- | - | -------------- |  | ----- | ------- |  | - | -------
|                                      |  | June 30, 2008  
|                                      |  | One Yearor Less |         | Over OneYearthroughFive Years |   | Over FiveYears |  | Total
|                                      |  | Unaudited      
|Real estate and construction loans(1) |  |                 |         |                               |   |                |  |       |         |  |   |        
|Floating rate                         |  | $               | 49,463  |                               | $ | 15,812         |  | $     | 171,326 |  | $ | 236,601
|Fixed rate                            |  |                 | 32,887  |                               |   | 61,514         |  |       | 30,020  |  |   | 124,421
|Commercial loans                      |  |                 |         |                               |   |                |  |       |         |  |   |        
|Floating rate                         |  |                 | 91,071  |                               |   | 25,324         |  |       | 5,371   |  |   | 121,766
|Fixed rate                            |  |                 | 92,712  |                               |   | 47,608         |  |       | 9,709   |  |   | 150,029
|                                      |  |                 |         |                               |   |                |  |       |         |  |   |        
|Total                                 |  | $               | 266,133 |                               | $ | 150,258        |  | $     | 216,426 |  | $ | 632,817
|                                      |  |                 |         |                               |   |                |  |       |         |  |   |        



|(1) | Does not include mortgage loans on single and multi-family residences and consumer loans, which totaled $156.3 million
and $7.7 million, respectively, at June 30, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Allowance for Loan Losses and Nonperforming Loans

Allowance for Loan Losses. The allowance for loan losses (the Allowance) at June 30, 2008 was $7.1 million,
which represented approximately 0.89% of the loans outstanding at June 30, 2008, as compared to $6.1 million, or 0.79%, of the loans outstanding at December 31, 2007.

We carefully monitor changing economic conditions, the loan portfolio by category, the financial condition of borrowers, the historical performance of
the loan portfolio, and we follow bank regulatory guidelines in determining the adequacy of the allowance. We believe that the allowance at June 30, 2008 was adequate to provide for losses inherent in the loan portfolio. However, as the volume
of loans increases, additional provisions for loan losses will be required to maintain the allowance at adequate levels. Additionally, the allowance was established on the basis of assumptions and judgments regarding such matters as economic
conditions and trends and the condition of borrowers, historical industry loan loss data and regulatory guidelines and, if there are changes in those conditions or trends, such as those that occurred during the first six months of 2008, actual loan
losses in the future could vary from the losses that were predicted on the basis of those earlier assumptions, judgments and guidelines. For example, if economic conditions were to deteriorate further, or interest rates were to increase
significantly, which would have the effect of increasing the risk that borrowers would encounter difficulties meeting their loan payment obligations, it could become necessary to increase the allowance by means of additional provisions for loan
losses. See Results of OperationsProvision for Loan Losses above.

Set forth below is a summary, in
thousands of dollars, of the transactions in the allowance for loan losses for the six months ended June 30, 2008 and the year ended December 31, 2007:



|                             |  |                               |        |   |                             |   |        |  
|---------------------------- |  | ----------------------------- | ------ | - | --------------------------- | - | ------ | -
|                             |  | Six Months EndedJune 30, 2008 |        |   | Year EndedDecember 31, 2007 |  
|                             |  | Unaudited                     |       
|Balance, beginning of period |  | $                             | 6,126  |   |                             | $ | 5,929  |  
|Provision for loan losses    |  |                               | 3,816  |   |                             |   | 2,025  |  
|Net, amounts charged off     |  |                               | (2,869 | ) |                             |   | (1,828 | )
|                             |  |                               |        |   |                             |   |        |  
|Balance, end of period       |  | $                             | 7,073  |   |                             | $ | 6,126  |  
|                             |  |                               |        |   |                             |   |        |  

Non-Performing Loans. We also measure and establish reserves for loan impairments on a
loan-by-loan basis using either the present value of expected future cash flows discounted at a loans effective interest rate, or the fair value of the collateral if the loan is collateral-dependent. We exclude smaller, homogeneous loans, such
as consumer installment loans and lines of credit, from our impairment calculations. Also, loans that experience insignificant payment delays or shortfalls are generally not considered impaired. We generally cease accruing interest, and therefore
classify as nonaccrual, any loan as to which principal or interest has been in default for a period of 90 days or more, or if repayment in full of interest or principal is not expected.



26



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##### Table of Contents

At June 30, 2008 and December 31, 2007, we had loans totaling $11.6 million and $8.0 million,
respectively, that were delinquent and which were classified as nonaccrual and impaired loans. The increase in non-performing loans at June 30, 2008, as compared to December 31, 2007, was mainly attributable to three
construction/development loans, in an aggregate amount of $7.6 million, which had become delinquent and were placed on nonaccrual status during the first six months of 2008. However, we believe that all of these loans are well-collateralized and/or
adequately reserved.

Loans delinquent 90 days or more totaled $10.8 million at June 30, 2008; whereas $7.7 million of loans
were delinquent 90 days or more as of December 31, 2007. We had two troubled debt restructured loans at June 30, 2008 that were continuing to accrue interest, increasing the amount of restructured loans to $3.3 million compared to $300,000
at December 31, 2007. At June 30, 2008, our average investment in impaired loans was $8.5 million. The interest that we would have earned during the three and six months ended June 30, 2008, if the impaired loans had remained current
in accordance with their original terms, were $226,000 and $421,000, respectively.

Other Nonperforming Assets

Other real estate owned totaled $3.4 million at June 30, 2008 as compared to $425,000 at December 31, 2007. At June 30, 2008 there was
one single family residence and one construction/development project that were classified as other real estate owned. We anticipate that the construction/development project will be sold in the third quarter of 2008. The single family residence is
currently listed for sale with an unaffiliated real estate brokerage firm.

Deposits

Average Balances of and Average Interest Rates Paid on Deposits. Set forth below are the average amounts (in thousands of dollars) of, and the
average rates paid on, deposits for the six months ended June 30, 2008:



|                                    |  |                               |         |             |      |  
|----------------------------------- |  | ----------------------------- | ------- | ----------- | ---- | -
|                                    |  | Six Months EndedJune 30, 2008 |        
|                                    |  | Unaudited                     |        
|                                    |  | AverageBalance                |         | AverageRate |     
|Noninterest-bearing demand deposits |  | $                             | 160,591 |             |     |  
|Interest-bearing checking accounts  |  |                               | 19,280  |             | 0.57 | %
|Money market and savings deposits   |  |                               | 151,938 |             | 2.29 | %
|Time deposits                       |  |                               | 422,347 |             | 4.87 | %
|                                    |  |                               |         |             |      |  
|Average total deposits              |  | $                             | 754,156 |             | 4.07 | %
|                                    |  |                               |         |             |      |  

Deposit Totals. Deposits totaled $761 million at June 30, 2008 as compared to $747
million at December 31, 2007. At June 30, 2008, noninterest-bearing deposits totaled $163 million and represented 21% of total deposits, as compared to $188 million and 25% of total deposits at December 31, 2007. At June 30,
2008, certificates of deposit in denominations of $100,000 or more totaled $260 million and represented 34% of total deposits, as compared to $229 million and 31% of total deposits at December 31, 2007. We believe that the decline in
noninterest bearing deposits was primarily attributable to the economic downturn. We increased the volume of the time certificates of deposits in order to offset, on a short-term basis, the decline in non-interest-bearing deposits and to provide
additional funds primarily for loans.



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Set forth below, in thousands of dollars, is a maturity schedule of domestic time certificates of deposit
outstanding at June 30, 2008:



|                                     |  |                                      |         |                                           |   |        
|------------------------------------ |  | ------------------------------------ | ------- | ----------------------------------------- | - | -------
|                                     |  | At June 30, 2008                    
|                                     |  | Certificates of DepositUnder$100,000 |         | Certificates of Depositof $100,000or More
|                                     |  | Unaudited                           
|Maturities                           |  |                                      |         |                                           |   |        
|Three months or less                 |  | $                                    | 46,200  |                                           | $ | 92,821 
|Over three and through twelve months |  |                                      | 96,981  |                                           |   | 122,100
|Over twelve months                   |  |                                      | 41,994  |                                           |   | 45,350 
|                                     |  |                                      |         |                                           |   |        
|Total certificates of deposit        |  | $                                    | 185,175 |                                           | $ | 260,271
|                                     |  |                                      |         |                                           |   |        

Liquidity

We actively manage our liquidity needs to ensure that sufficient funds are available to meet our needs for cash, including to fund new loans to and deposit withdrawals by our customers. We project the future sources
and uses of funds and maintain sufficient liquid funds for unanticipated events. Our primary sources of cash include payments on loans, proceeds from the sale or maturity of investments, increases in deposits and increases in borrowings principally
from the Federal Home Loan Bank. The primary uses of cash include funding new loans and making advances on existing lines of credit, purchasing investments, including securities available for sale, funding deposit withdrawals and paying operating
expenses. We maintain funds in overnight federal funds and other short-term investments to provide for short-term liquidity needs. We also have obtained credit lines from the Federal Home Loan Bank and other financial institutions to meet any
additional liquidity requirements.

Our liquid assets, which included cash and due from banks, federal funds sold, interest earning
deposits with financial institutions and unpledged securities available for sale (excluding Federal Reserve Bank and Federal Home Loan Bank stock) totaled $121 million, which represented 10.8% of total assets at June 30, 2008.

Cash Flow Provided by Operating Activities. Cash flow of $2.1 million was provided by operating activities during the six months ended
June 30, 2008.

Cash Flow Used in Investing Activities. In the six months ended June 30, 2008, we used $39 million in
investing activities, together with $80 million in cash generated by sales of securities and $22 million from maturities of and principal payments received on securities available for sale, primarily to fund $118 million in purchases of
securities and $25 million to fund an increase in loans.

Cash Flow Provided by Financing Activities. Cash flow of $48 million
was provided by financing activities during the six months ended June 30, 2008, comprised of net increases of $36 million in borrowings and $14 million in deposits.

Ratio of Loans to Deposits.The relationship between gross loans and total deposits can provide a useful measure of a banks
liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio the less liquid are our assets. On the other hand, since we realize greater yields and
higher interest income on loans than we do on investments, a lower loan-to-deposit ratio can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the requirements of
liquidity and the need to generate a fair return on assets. At both June 30, 2008 and December 31, 2007 the ratios of loans-to-deposits were 104%.

Off Balance Sheet Arrangements

Loan Commitments and Standby Letters of Credit. In order to meet the financing needs
of our customers, in the normal course of business we make commitments to extend credit and issue standby commercial letters of credit to or for our customers. At June 30, 2008 and December 31, 2007, we were committed to fund certain loans
amounting to approximately $217 million and $237 million, respectively.



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Commitments to extend credit and standby letters of credit generally have fixed expiration dates or other
termination clauses and the customer may be required to pay a fee and meet other conditions in order to draw on those commitments or standby letters of credit. We expect, based on historical experience, that many of the commitments will expire
without being drawn upon and, therefore, the total commitment amounts do not necessarily represent future cash requirements.

To varying
degrees, commitments to extend credit involve elements of credit and interest rate risk for us that are in excess of the amounts recognized in our balance sheets. Our maximum exposure to credit loss in the event of nonperformance by the customers to
whom such commitments are made could potentially be equal to the amount of those commitments. As a result, before making such a commitment to a customer, we evaluate the customers creditworthiness using the same underwriting standards that we
would apply if we were approving loans to the customer. In addition, we often require the customer to secure its payment obligations for amounts drawn on such commitments with collateral such as accounts receivable, inventory, property, plant and
equipment, income-producing commercial properties, residential properties and properties under construction. As a consequence, our exposure to credit and interest rate risk on such commitments is not different in character or amount than risks
inherent in the outstanding loans in our loan portfolio.

Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

We believe that our cash and cash equivalent resources, together with available borrowings under our credit facilities, will be sufficient to enable us
to meet any increases in demand for loans or in the utilization of outstanding loan commitments or standby letters of credit and any increase in deposit withdrawals that might occur in the foreseeable future.

Contractual Obligations

Borrowings. As a
source of additional funds that we have used primarily to fund loans and to purchase other interest earning assets, and to provide us with a supplemental source of liquidity, we have obtained long and short term borrowings from the Federal Home Loan
Bank (the FHLB). As of June 30, 2008, we had $135 million of outstanding long-term borrowings, with maturities ranging from November 2009 to December 2010, and $101 million of outstanding short-term borrowings, with
maturities ranging from July 2008 to May 2009 that we had obtained from the Federal Home Loan Bank. These borrowings, together with securities sold under agreements to repurchase, have a weighted-average annualized interest rate of 4.63%. By
comparison, as of December 31, 2007, we had $118 million of outstanding long-term borrowings and $84 million of outstanding short-term borrowings that we had obtained from the Federal Home Loan Bank, which, together with the
securities sold under agreements to repurchase, had a weighted-average annualized interest rate of 4.98%

At June 30, 2008, U.S.
agency and mortgage backed securities, U.S. Government agency securities and collateralized mortgage obligations with an aggregate fair market value of $174 million and $176 million of residential mortgage and other real estate secured
loans were pledged to secure these Federal Home Loan Bank borrowings, repurchase agreements, local agency deposits, and treasury, tax and loan accounts.

The highest amount of borrowings that were outstanding at any month-end during the six months ended June 30, 2008 consisted of $236 million of borrowings from the Federal Home Loan Bank and $9 million
of overnight borrowings in the form of securities sold under repurchase agreements. During 2007, the highest amount of borrowings outstanding at any month-end consisted of $231 million of advances from the Federal Home Loan Bank and
$10 million of overnight borrowings in the form of securities sold under repurchase agreements.

Junior Subordinated
Debentures. Pursuant to rulings of the Federal Reserve Board, bank holding companies have been permitted to issue long term subordinated debt instruments that will, subject to certain conditions, qualify as and, therefore, augment capital for
regulatory purposes. Pursuant to those rulings, in 2002, we formed subsidiary grantor trusts to sell and issue to institutional investors a total of approximately $17.5 million principal amount of floating junior trust preferred securities
(trust preferred securities). We received the net proceeds from the sale of the trust preferred securities in exchange for our issuance to the grantor trusts, of a total $17.5 million principal amount of our junior subordinated floating
rate debentures (the Debentures), the payment terms of which mirror those of the



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trust preferred securities. The payments we make on the Debentures are used by the grantor trusts to make the corresponding payments on the trust preferred
securities and the Debentures are pledged as security for the payment obligations of the grantor trusts with respect to the trust preferred securities.

In October 2004, we established another grantor trust that sold an additional $10.3 million of trust preferred securities to an institutional investor and, in connection therewith, we sold and issued an
additional $10.3 million principal amount of junior subordinated floating rate debentures in exchange for the proceeds raised from the sale of those trust preferred securities.

During the quarter ended September 2007, we voluntarily redeemed, at par, $10.3 million principal amount of the Debentures that we issued in 2002.

Set forth below are the respective principal amounts, in thousands of dollars, and certain other information regarding the terms, of the
Debentures that remained outstanding as of June 30, 2008:



|                     |  |                  |        |                  |                 |   |                |               
|-------------------- |  | ---------------- | ------ | ---------------- | --------------- | - | -------------- | --------------
|Original Issue Dates |  | Principal Amount |        | Interest Rate(1) |                 |   | Maturity Dates
|September 2002       |  | $                | 7,217  |                  | LIBOR plus 3.40 | % |                | September 2032
|October 2004         |  |                  | 10,310 |                  | LIBOR plus 2.00 | % |                | October 2034  
|                     |  |                  |        |                  |                 |   |                |               
|Total                |  | $                | 17,527 |                  |                 |   |                |               
|                     |  |                  |        |                  |                 |   |                |               



|(1) | Interest rate resets quarterly.
|--- | -------------------------------

These Debentures require quarterly interest payments. Subject to certain conditions, we have the right, at our discretion, to defer those interest
payments for up to five years. However, we have no need and have no plans to exercise this deferral right.

Under the Federal Reserve Board
rulings, the borrowings evidenced by the Debentures, which are subordinated to all of our other borrowings that are outstanding or which we may obtain in the future, are eligible (subject to certain dollar limitations) to qualify, and at
June 30, 2008, all $17.5 million principal amount of those Debentures qualified as Tier I capital for regulatory purposes.

These
Debentures are redeemable, at our option, without premium or penalty, beginning five years after their respective original issue dates. As noted above, we exercised this voluntary redemption right to redeem $10.3 million principal amount of the
Debentures that we issued in 2002.

Investment Policy and Securities Available for Sale

Our investment policy is designed to provide for our liquidity needs and to generate a favorable return on investments without undue interest rate risk,
credit risk or asset concentrations.

Our investment policy:



| |  |  | authorizes us to invest in obligations issued or fully guaranteed by the United States Government, certain federal agency obligations, time deposits issued by
federally insured depository institutions, municipal securities and in federal funds sold;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that the weighted average maturities of U.S. Government obligations and federal agency securities cannot exceed 10 years and municipal obligations cannot
exceed 25 years;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that time deposits must be placed with federally insured financial institutions, cannot exceed $100,000 in any one institution and may not have a maturity
exceeding 60 months; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibits engaging in securities trading activities.
| | - |  | ----------------------------------------------------



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Securities available for sale are those that we intend to hold for an indefinite period of time, but
which may be sold in response to changes in liquidity needs, changes in interest rates, changes in prepayment risks or other similar factors. Such securities are recorded at fair value. Any unrealized gains and losses are reported as Other
Comprehensive Income (Loss) rather than included in or deducted from earnings.

The following is a summary of the major components of
securities available for sale and a comparison of the amortized cost, estimated fair values and gross unrealized gains and losses, in thousands of dollars, as of June 30, 2008 and December 31, 2007:



|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|-------------------------------------------- |  | ------------- | ------- | ------------------- | - | ------------------- |  | - | ------------------- | - |  | - | -------
|                                             |  | AmortizedCost |         | GrossUnrealizedGain |   | GrossUnrealizedLoss |  |   | EstimatedFair Value
|                                             |  |               |         | Unaudited           |   |                     | 
|June 30, 2008                                |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Securities Available For Sale:               |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|US Agencies/Mortgage-backed securities       |  | $             | 197,627 |                     | $ | 202                 |  | $ | (4,995              | ) |  | $ | 192,834
|Collateralized mortgage obligations          |  |               | 11,768  |                     |   |                    |  |   | (528                | ) |  |   | 11,240 
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total government and agencies securities     |  |               | 209,395 |                     |   | 202                 |  |   | (5,523              | ) |  |   | 204,074
|Municipal securities                         |  |               | 22,894  |                     |   | 30                  |  |   | (826                | ) |  |   | 22,098 
|Asset backed securities                      |  |               | 2,854   |                     |   |                    |  |   | (602                | ) |  |   | 2, 252 
|Mutual fund                                  |  |               | 1,721   |                     |   |                    |  |   |                    |   |  |   | 1, 721 
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total Securities Available For Sale          |  | $             | 236,864 |                     | $ | 232                 |  | $ | (6,951              | ) |  | $ | 230,145
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|December 31, 2007                            |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Securities Available For Sale:               |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|U.S. agencies and mortgage-backed securities |  | $             | 174,370 |                     | $ | 511                 |  | $ | (1,693              | ) |  | $ | 173,188
|Collateralized mortgage obligations          |  |               | 18,885  |                     |   |                    |  |   | (376                | ) |  |   | 18,509 
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total government and agencies securities     |  |               | 193,255 |                     |   | 511                 |  |   | (2,069              | ) |  |   | 191,697
|Municipal securities                         |  |               | 22,893  |                     |   | 65                  |  |   | (417                | ) |  |   | 22,541 
|Asset backed securities                      |  |               | 2,857   |                     |   |                    |  |   | (5                  | ) |  |   | 2,852  
|Mutual fund                                  |  |               | 1,748   |                     |   |                    |  |   |                    |   |  |   | 1,748  
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total Securities Available For Sale          |  | $             | 220,753 |                     | $ | 576                 |  | $ | (2,491              | ) |  | $ | 218,838
|                                             |  |               |         |                     |   |                     |  |   |                     |   |  |   |        

At June 30, 2008, U.S. agencies and mortgage backed securities, U.S. Government agency
securities and collateralized mortgage obligations with an aggregate fair market value of $174 million were pledged to secure Federal Home Loan Bank borrowings, repurchase agreements, local agency deposits and treasury, tax and loan accounts.

The amortized cost and estimated fair value, at June 30, 2008, of securities available for sale are shown, in thousands of dollars,
in the following table, by contractual maturities and historical prepayments based on the prior six months of principal payments. Expected maturities will differ from contractual maturities and historical prepayments, particularly with respect to
collateralized mortgage obligations, because borrowers may react to interest rate market conditions differently than the historical prepayment rates.



|                                         |  |                          |        |                      |                                |   |            |                                 |                      |  |               |            |  |                      |        |  |            |   |                      |   |        |            |      |                      |  |   |         |  |      |  
|---------------------------------------- |  | ------------------------ | ------ | -------------------- | ------------------------------ | - | ---------- | ------------------------------- | -------------------- |  | ------------- | ---------- |  | -------------------- | ------ |  | ---------- | - | -------------------- | - | ------ | ---------- | ---- | -------------------- |  | - | ------- |  | ---- | -
|                                         |  | June 30, 2008Maturing in |       
|                                         |  | One yearor less          |        |                      | Over oneyear throughfive years |   |            | Over fiveyears throughten years |                      |  | Over tenyears |            |  | Total                |       
|                                         |  | Book Value               |        | WeightedAverageYield |                                |   | Book Value |                                 | WeightedAverageYield |  |               | Book Value |  | WeightedAverageYield |        |  | Book Value |   | WeightedAverageYield |   |        | Book Value |      | WeightedAverageYield | 
|                                         |  | (Dollars in thousands)   |       
|Securities available for sale(1):        |  |                          |        |                      |                                |   |            |                                 |                      |  |               |            |  |                      |        |  |            |   |                      |   |        |            |      |                      |  |   |         |  |      |  
|U.S. Agencies/Mortgage backed securities |  | $                        | 35,401 |                      | 4.19                           | % |            | $                               | 86,273               |  | 4.26          | %          |  | $                    | 42,782 |  | 4.48       | % |                      | $ | 33,171 |            | 4.70 | %                    |  | $ | 197,627 |  | 4.37 | %
|Collateralized mortgage obligations      |  |                          | 2,268  |                      | 4.49                           | % |            |                                 | 4,220                |  | 4.55          | %          |  |                      | 5,280  |  | 4.49       | % |                      |   |       |            |     |                      |  |   | 11,768  |  | 4.51 | %
|Municipal securities                     |  |                          |       |                      |                               |   |            |                                 |                     |  |              |            |  |                      | 3,130  |  | 4.10       | % |                      |   | 19,764 |            | 4.26 | %                    |  |   | 22,894  |  | 4.24 | %
|Asset backed securities                  |  |                          |       |                      |                               |   |            |                                 |                     |  |              |            |  |                      |       |  |           |   |                      |   | 2,854  |            | 3.63 | %                    |  |   | 2,854   |  | 3.63 | %
|Total Securities Available for sale(1)   |  | $                        | 37,669 |                      | 4.20                           | % |            | $                               | 90,493               |  | 4.27          | %          |  | $                    | 51,192 |  | 4.46       | % |                      | $ | 55,789 |            | 4.49 | %                    |  | $ | 235,143 |  | 4.36 | %



|(1) | Mutual fund securities of $1.721 million are excluded from the
above table, as they do not have stated maturity dates.
|--- | ----------------------------------------------------------------------------------------------------------------------



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The table below shows as of June 30, 2008, the gross unrealized losses and fair values (in thousands
of dollars) of our investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.



|                                           |  |                                                     |         |                |                   |        |            |       |                |        |  |            |        |                |  |   |         |  |   |        |  
|------------------------------------------ |  | --------------------------------------------------- | ------- | -------------- | ----------------- | ------ | ---------- | ----- | -------------- | ------ |  | ---------- | ------ | -------------- |  | - | ------- |  | - | ------ | -
|                                           |  | Securities With Unrealized Loss as of June 30, 2008 |        
|                                           |  | Less than 12 months                                 |         |                | 12 months or more |        |            | Total |               
|                                           |  | Fair Value                                          |         | UnrealizedLoss |                   |        | Fair Value |       | UnrealizedLoss |        |  | Fair Value |        | UnrealizedLoss | 
|(Dollars In thousands)                     |  | Unaudited                                           |        
|US agencies and mortgage backed securities |  | $                                                   | 125,398 |                | $                 | (4,356 | )          |       | $              | 27,024 |  | $          | (639   | )              |  | $ | 152,422 |  | $ | (4,995 | )
|Collateralized mortgage obligations        |  |                                                     | 3,703   |                |                   | (190   | )          |       |                | 7,537  |  |            | (338   | )              |  |   | 11,240  |  |   | (528   | )
|Asset backed securities                    |  |                                                     | 2,252   |                |                   | (602   | )          |       |                |       |  |            |       |                |  |   | 2,252   |  |   | (602   | )
|Municipal securities                       |  |                                                     | 17,430  |                |                   | (632   | )          |       |                | 1,608  |  |            | (194   | )              |  |   | 19,038  |  |   | (826   | )
|                                           |  |                                                     |         |                |                   |        |            |       |                |        |  |            |        |                |  |   |         |  |   |        |  
|Total temporarily impaired securities      |  | $                                                   | 148,783 |                | $                 | (5,780 | )          |       | $              | 36,169 |  | $          | (1,171 | )              |  | $ | 184,952 |  | $ | (6,951 | )
|                                           |  |                                                     |         |                |                   |        |            |       |                |        |  |            |        |                |  |   |         |  |   |        |  

We regularly monitor investments for significant declines in fair value. We have determined that
the declines in the fair values of these investments below their amortized costs, as set forth in the table above, are temporary based on the following: (i) those declines are due to interest rate changes and not due to a deterioration in the
creditworthiness of the issuers of those investment securities, and (ii) we have the ability to hold those securities until there is a recovery in their values or until their maturity.

Capital Resources

Capital
Regulatory Requirements Applicable to Banking Institutions. Under federal banking regulations that apply to all United States based bank holding companies and federally insured banks, the Company (on a consolidated basis) and the Bank (on a
stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures primarily in terms of the ratios of their capital to their assets, liabilities, and certain off-balance sheet items calculated
under regulatory accounting practices. Under those regulations, based primarily on those quantitative measures each bank holding company must meet a minimum capital ratio and each federally insured bank is determined by its primary federal bank
regulatory agency to come within one of the following categories.



| |  |  | well capitalized
| | - |  | ----------------



| |  |  | adequately capitalized
| | - |  | ----------------------



| |  |  | undercapitalized
| | - |  | ----------------



| |  |  | significantly undercapitalized; or
| | - |  | ----------------------------------



| |  |  | critically undercapitalized
| | - |  | ---------------------------

Certain
qualitative assessments also are made by a banking institutions primary federal regulatory agency that could lead the agency to determine that the banking institution should be assigned to a lower capital category than the one indicated by the
quantitative measures used to assess the institutions capital adequacy. At each successive lower capital category, a bank is subject to greater operating restrictions and increased regulatory supervision by its federal bank regulatory agency.



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The following table sets forth the capital and capital ratios of the Company (on a consolidated basis)
and the Bank (on a stand alone basis) at June 30, 2008, as compared to the respective minimum regulatory requirements applicable to them.



|                                        |  |                        |         |       |                          |   |                                           |                                   |        |  |              |        |  |       |        |  |               |  
|--------------------------------------- |  | ---------------------- | ------- | ----- | ------------------------ | - | ----------------------------------------- | --------------------------------- | ------ |  | ------------ | ------ |  | ----- | ------ |  | ------------- | -
|                                        |  |                        |         |       |                          |   | Applicable Federal Regulatory Requirement |                                  
|                                        |  | Actual                 |         |       | Capital AdequacyPurposes |   |                                           | To be Categorized WellCapitalized |       
|                                        |  | Amount                 |         | Ratio |                          |   | Amount                                    |                                   | Ratio  |  |              | Amount |  | Ratio |       
|                                        |  | (Dollars in thousands) |        
|Total Capital to Risk Weighted Assets:  |  |                        |         |       |                          |   |                                           |                                   |        |  |              |        |  |       |        |  |               |  
|Company                                 |  | $                      | 121,692 |       | 14.1                     | % |                                           | $                                 | 69,166 |  | At least 8.0 | %      |  |       | N/A    |  | N/A           |  
|Bank                                    |  |                        | 95,977  |       | 11.2                     | % |                                           |                                   | 68,814 |  | At least 8.0 | %      |  | $     | 86,018 |  | At least 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |                        |         |       |                          |   |                                           |                                   |        |  |              |        |  |       |        |  |               |  
|Company                                 |  | $                      | 114,324 |       | 13.2                     | % |                                           | $                                 | 34,583 |  | At least 4.0 | %      |  |       | N/A    |  | N/A           |  
|Bank                                    |  |                        | 88,647  |       | 10.3                     | % |                                           |                                   | 34,407 |  | At least 4.0 | %      |  | $     | 51,611 |  | At least 6.0  | %
|Tier 1 Capital to Average Assets:       |  |                        |         |       |                          |   |                                           |                                   |        |  |              |        |  |       |        |  |               |  
|Company                                 |  | $                      | 114,324 |       | 10.1                     | % |                                           | $                                 | 45,083 |  | At least 4.0 | %      |  |       | N/A    |  | N/A           |  
|Bank                                    |  |                        | 88,647  |       | 7.9                      | % |                                           |                                   | 44,816 |  | At least 4.0 | %      |  | $     | 56,020 |  | At least 5.0  | %

At June 30, 2008 the Bank (on a stand-alone basis) continued to qualify as a well-capitalized
institution, and the Company continued to exceed the minimum required capital ratios, under the capital adequacy guidelines described above.

The consolidated total capital and Tier 1 capital of the Company, at June 30, 2008, include an aggregate of $17.5 million principal amount of Junior Subordinated Debentures that we issued in 2002 and 2004 in connection with the
sale of trust preferred securities. We contributed $17.5 million of the net proceeds from the sale of the trust preferred securities to the Bank, thereby increasing its total capital and Tier 1 capital.

Dividend Policy. Our Board of Directors has followed the policy of retaining earnings to support the growth of the Companys banking
franchise, but will consider paying cash dividends based on a number of factors, including prevailing market conditions and the availability and alternative uses that can be made of cash in excess of the requirements of the Companys business.

Pursuant to that policy, in February 2008, the Board of Directors declared a one-time cash dividend, in the amount of $0.10 per share of
common stock that was paid on March 14, 2008 to all shareholders of record as of February 29, 2008.

It continues to be the
policy of the Board to retain earnings to support future growth and, at the present time, there are no plans to declare any additional cash dividends, at least until economic conditions improve. However, the Board of Directors intends from time to
time to consider the advisability of paying additional dividends in the future. Any such decision will be based on a number of factors, including the Companys future financial performance, its available cash resources and any competing needs
for cash that the Company may have.

Share Repurchase Program.In September 2005, our Board of Directors concluded that, at
prevailing market prices, the Companys shares represented an attractive investment opportunity and, therefore, that repurchases of Company shares would be a good use of Company funds. As a result, the Board of Directors approved a share
repurchase program, which authorized the Company to purchase up to two percent (2%) of the Companys outstanding common shares, which approximates 200,000 shares in total. Pursuant to that program, share purchases may be made in the open
market or in private transactions, in accordance with applicable Securities and Exchange Commission rules, when opportunities become available to purchase shares at prices believed to be attractive. The Company is under no obligation to repurchase
shares under the share repurchase program and the timing, actual number and value of shares that are repurchased by the Company under this program will depend on a number of factors, including the Companys future financial performance and
available cash resources, competing uses for its corporate funds, prevailing market prices of its common stock and the number of shares that become available for sale at prices that the Company believes are attractive, as well as any regulatory
requirements applicable to the Company. To date we have purchased 105,354 shares under this program.



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During April 2008, we made open market purchases of an aggregate of 20,000 shares of our common stock
pursuant to this program for an aggregate purchase price of $180,000, which results in an average per share price of $9.04. During June 2008, we made open market purchases of an aggregate of 15,054 shares of our common stock for an aggregate
purchase price of $109,000, which results in an average per share price of $7.22.

Risks That Could Affect Our Future Financial Performance

This Report, including the discussion and analysis of our financial condition and results of operations set forth above, contains
certain forward-looking statements. Forward-looking statements set forth are estimates of, or our expectations, beliefs or views regarding our future financial performance that are based on current information and that are subject to a number of
risks and uncertainties that could cause our actual operating results and financial performance in the future to differ significantly from those expected at the current time. Those risks and uncertainties include, although they are not limited to,
the following:

We face intense competition from other banks and financial institutions that could hurt our business

We conduct our business operations in Southern California, where the banking business is highly competitive and is dominated by a
relatively small number of large multi-state banks with operations and offices covering wide geographical areas. We also compete with other financial service businesses, mutual fund companies, and securities brokerage and investment banking firms
that offer competitive banking and financial products and services as well as products and services that we do not offer. The larger banks, and some of those other financial institutions, have greater resources that enable them to conduct extensive
advertising campaigns and to shift resources to regions or activities of greater potential profitability. Some of these banks and institutions also have substantially more capital and higher lending limits that enable them to attract larger clients,
and offer financial products and services that we are unable to offer, particularly with respect to attracting loans and deposits. Increased competition may prevent us (i) from achieving increases, or could even result in decreases, in our loan
volume or deposit balances, or (ii) from increasing interest rates on loans or reducing interest rates we pay to attract or retain deposits, any of which could cause a decline in our interest income or an increase in our interest expense, that
could lead to reductions in our net interest income and earnings.

Adverse changes in economic conditions in Southern California
could disproportionately harm our business

The large majority of our customers and the properties securing a large proportion of
our loans are located in Southern California. A downturn in economic conditions or the occurrence of natural disasters in Southern California could harm our business by:



| |  |  | reducing loan demand which, in turn, would lead to reduced net interest margins and net interest income;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | affecting the financial capability of borrowers to meet their loan obligations, which could result in increases in loan losses that would require us to make
additional provisions for possible loan losses and possibly acquire, through foreclosure, real properties securing some of our loans in an effort to minimize loan losses, which would cause us to incur additional expenses and result in reduced
earnings; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | causing reductions in real property values that, due to our reliance on real property to secure many of our loans, could make it more difficult for us to prevent
losses from being incurred on non-performing loans through the sale of such real properties.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

National economic
conditions and changes in Federal Reserve Board monetary policies could affect our operating results

Our ability to achieve and
sustain profitability is substantially dependent on our net interest income. Like most banking organizations and other depository institutions, our net interest income is affected by a number of factors outside of our control, including changes in
market rates of interest, that occur from time to time as a result of changes in national economic conditions, and changes by the Federal Reserve Board in its monetary policies in response to threats of increased inflation, a slowing of economic
growth or the on-set of recessionary conditions. For example,



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interest rate reductions by the Federal Reserve Board or a slowing of the economy can result in decreases in the interest we can earn on loans and other
interest-earning assets, as occurred during the quarter and six months ended June 30, 2008. Also, our net interest margin and net interest income could decline if we are not able, in response to such conditions, to reduce the interest rates we
must pay on deposits and other interest-bearing liabilities to the same extent as we are required to reduce the rates we are able to charge on the loans we make. Adverse changes in economic conditions also (i) could cause potential borrowers to
fail to qualify for our loan products and reduce loan demand, thereby reducing our net interest margins and our net interest income and (ii) could cause increases in loan defaults which could result in an increase in loan losses and could
require us to increase the provisions we must make for possible loan losses, which would reduce our income.

We could incur losses on
the loans we make

The failure or inability of borrowers to repay their loans is an inherent risk in the banking business. We take a
number of measures designed to reduce this risk, including the maintenance of stringent loan underwriting policies, the establishment of reserves for possible loan losses and the requirement that borrowers provide collateral that we could sell in
the event they fail to pay their loans. However, the ability of borrowers to repay their loans, the adequacy of our reserves and our ability to sell collateral for amounts sufficient to offset loan losses are affected by a number of factors outside
of our control, such as changes in economic conditions, increases in market rates of interest and changes in the condition or value of the collateral securing our loans. As a result, we could incur losses on the loans we make that will hurt our
operating results and weaken our financial condition.

Expansion of existing financial centers might not achieve expected growth or
increases in profitability

We have grown substantially during the nine years since our inception by (i) opening new financial
centers in population centers, and (ii) adding banking professionals at our existing financial centers, with the objective of attracting additional customers including, in particular, small to medium size businesses, that will add to our
profitability. We intend to continue that growth strategy. However, there is no assurance that we will continue to be successful in achieving this objective. Implementation of this strategy will require us to incur expenses in establishing new
financial centers or adding banking professionals, long before we are able to attract, and with no assurance that we will succeed in attracting, a sufficient number of new customers that will enable us to generate the revenues needed to increase our
profitability. As a result, our earnings could decline if we are unable to successfully implement this strategy.

Government
regulations may impair our operations, restrict our growth or increase our operating costs

We are subject to extensive supervision
and regulation by federal and state bank regulatory agencies. The primary objective of these agencies is to protect bank depositors and other customers and not shareholders, whose respective interests will often differ. The regulatory agencies have
the legal authority to impose restrictions which they believe are needed to protect depositors and customers of banking institutions, even if those restrictions would adversely affect the ability of the banking institution to expand its business or
pay cash dividends, or result in increases in its costs of doing business or hinder its ability to compete with financial services companies that are not regulated or banks or financial service organizations that are less regulated. Additionally,
due to the complex and technical nature of many of the government regulations to which banking organizations are subject, inadvertent violations of those regulations may occur. In such an event, we would be required to correct or implement measures
to prevent a recurrence of such violations. If more serious violations were to occur, the regulatory agencies could limit our activities or growth, fine us or ultimately put us out of business.

Our computer and network systems may be vulnerable to unforeseen problems and security risks

The computer systems and network infrastructure that we use to provide automated and internet banking services could be vulnerable to unforeseen problems.
Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure, earthquakes and similar catastrophic events and from security breaches. Any of those occurrences could
result in damage to or a failure of our computer systems that could cause an interruption in our banking services and, therefore, harm our business, operating results and financial condition. Additionally, interruptions in service and security
breaches that could result in the theft of confidential customer information could lead existing customers to terminate their banking relationships with us and could make it more difficult for us to attract new banking customers.



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The loss of key personnel could hurt our financial performance

Our success depends to a great extent on the continued availability of our existing management and, in particular, on Raymond E. Dellerba, our President
and Chief Executive Officer. In addition to their skills and experience as bankers, our executive officers provide us with extensive community ties upon which our competitive strategy is partially based. As a result, the loss of the services of any
of these officers could harm our ability to implement our business strategy or our future operating results.

Other Risks

Other risks that could affect our future financial performance are described in Item 1A, entitled Risk Factors in our
Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, and readers are urged to review those risks as well.

Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward looking statements, which speak
only as of the date of this Report. We also disclaim any obligation to update forward-looking statements contained in this Report or in our Annual Report on Form 10-K.



|ITEM 3. | MARKET RISK
|------- | -----------

We are exposed to market risk as a
consequence of the normal course of conducting our business activities. The primary market risk to which we are exposed is interest rate risk. Our interest rate risk arises from the instruments, positions and transactions entered into for purposes
other than trading. They include loans, securities, deposit liabilities, and short-term borrowings. Interest rate risk occurs when assets and liabilities reprice at different times as market interest rates change. Interest rate risk is managed
within an overall asset/liability framework for the Company.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to provide reasonable assurance that information required to be disclosed in our reports filed under that Act (the
Exchange Act), such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the rules of the Securities and Exchange Commission. Our disclosure controls and procedures also are
designed to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of our disclosure controls and procedures in effect as of June 30, 2008. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of June 30, 2008, our disclosure controls and
procedures were effective to provide reasonable assurance that material information, relating to the Company and its consolidated subsidiaries, required to be included in our Exchange Act reports, such as this Quarterly Report on Form 10-Q, is made
known to management, including the Chief Executive Officer and Chief Financial Officer, on a timely basis.

There were no changes in our
internal control over financial reporting that occurred during the quarter or six months ended June 30, 2008 that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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PART II



|ITEM 1A. | RISK FACTORS
|-------- | ------------

There have been no material changes
from the risk factors that were disclosed under the caption Risk Factors in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, except as may otherwise be set forth above under the
caption Risks That Could Affect Our Future Financial Performance in Item 2 of Part I of this Report and except as follows:

There has been a recent increase in mortgage loan and real estate construction foreclosures throughout the United States, due primarily to increasing market rates of interest on variable rate mortgages and declining property values.
Although the vast majority of these foreclosures appear to involve borrowers who had financed home purchases or refinanced existing home mortgage loans with so-called subprime mortgage loans, mortgage loan foreclosures can result in increases in
loan losses and require mortgage lenders to take ownership of the foreclosed real properties in order to mitigate potential loan losses, which can result in increased non-interest expenses. Moreover, the recent increase in mortgage loan foreclosures
have led to the adoption of more stringent loan underwriting standards, which makes it more difficult for borrowers to qualify for loans. Additionally, during the past six months there has been a downturn in economic conditions and many economists
have expressed the view that the country is or will soon be in a recession, the duration and severity of which are uncertain. These conditions also could lead to reductions in loan demand and increases in loan defaults, which could require us to
increase the allowance for possible loan losses. We began to reduce our exposure to these risks when we discontinued our residential mortgage lending business in 2005 and, more recently, have begun reducing the volume of real estate construction
loans that we make. However, these conditions, coupled with reductions in interest rates by the Federal Reserve Board in an effort to prevent economic conditions from worsening, led to a decline in our net interest income and net income in the
quarter and six months ended June 30, 2008 and there are no assurances that these conditions will not continue to adversely affect our operating results in the future.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

Share Repurchases

The following table sets forth information regarding our share repurchases in each of the months during
the quarter ended June 30, 2008.



|                          |  |                                |  |                             |      |                                                                     |        |                                                                            |        
|------------------------- |  | ------------------------------ |  | --------------------------- | ---- | ------------------------------------------------------------------- | ------ | -------------------------------------------------------------------------- | -------
|                          |  | (a)                            |  | (b)                         |      | (c)                                                                 |        | (d)                                                                       
|                          |  | Total Numberof SharesPurchased |  | Average PricePaid per Share |      | Total Number ofShares Purchasedas Part of PubliclyAnnounced Program |        | Maximum Number ofRemaining Shares thatMay YetBe PurchasedUnder the Program
|April 1 to April 30, 2008 |  | 20,000                         |  | $                           | 9.04 |                                                                     | 20,000 |                                                                            | 109,700
|May 1 to May 31, 2008     |  |                               |  | $                           |     |                                                                     |       |                                                                            | 109,700
|June 1 to June 30, 2008   |  | 15,054                         |  | $                           | 7.22 |                                                                     | 15,054 |                                                                            | 94,646 
|                          |  |                                |  |                             |      |                                                                     |        |                                                                            |        
|Total                     |  | 35,054                         |  | $                           | 8.26 |                                                                     | 35,054 |                                                                            |        
|                          |  |                                |  |                             |      |                                                                     |        |                                                                            |        

The above shares were purchased pursuant to a stock repurchase program that was publicly announced
on July 28, 2005 and at that time authorized repurchases of up to approximately 200,000 of the Companys shares, in open market and private transactions, in accordance with applicable rules of the Securities and Exchange Commission. This
program does not have an expiration date. However, the Company may elect (i) to suspend share repurchases at any time or from time to time, or (ii) to terminate the program prior to the repurchase of all of the shares authorized for
repurchase under this program. Accordingly, there is no assurance that any additional shares will be repurchased under this program. To date we have purchased 105,354 shares under the program.



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|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

The Annual Meeting of Shareholders of the Company was held on May 22, 2008. At that Meeting, the shareholders elected the Directors of the Company for a term of one year, ending at the next Annual Meeting of Shareholders to be held in
May 2009.

(1) Directors Elected at the Annual Meeting. Set forth below is the name of each Director that was nominated and elected
at the Annual Meeting and the respective numbers of votes cast for their election and the respective number of votes withheld. As the election was uncontested, there were no broker non-votes.



|                     |  |            |  |          
|-------------------- |  | ---------- |  | ---------
|                     |  | Votes Cast
|                     |  | For        |  | Withheld 
|Raymond E. Dellerba  |  | 7,707,423  |  | 1,873,358
|George H. Wells      |  | 8,487,780  |  | 1,093,001
|Warren T. Finley     |  | 8,483,043  |  | 1,097,738
|Matthew F. Schafnitz |  | 8,511,544  |  | 1,069,237
|John Thomas, M.D.    |  | 8,375,530  |  | 1,205,251
|Gary M. Williams     |  | 8,511,795  |  | 1,068,986

(2) Approval of 2008 Equity Incentive Plan. The 2008 Equity Incentive Plan, which sets
aside 400,000 shares of the Companys common stock for the grant, to officers, directors and other key employees, of options, restricted rights to purchase such shares and stock appreciation rights (SARs), was approved by a majority
of the shares present and voting at the Annual Meeting, which was the vote required to approve the Plan. For this purpose, broker non-votes, which are counted for purposes of determining whether a quorum was present, in person or by proxy, at the
Meeting, are deemed not to have been voted on this matter.



|           |  |           |  |                  |  |                 
|---------- |  | --------- |  | ---------------- |  | ----------------
|Votes Cast
|For        |  | Against   |  | SharesAbstaining |  | Broker Non-Votes
|3,841,689  |  | 2,109,986 |  | 180,147          |  | 3,449,759       



|ITEM 6. | EXHIBITS
|------- | --------

The following documents are filed
Exhibits to the Quarterly Report on Form 10-Q:



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



|                      |  |  |  |                            |  |                                       
|--------------------- |  |  |  | -------------------------- |  | --------------------------------------
|                      |  |  |  | PACIFIC MERCANTILE BANCORP
|                      |  |  | 
|Date: August 11, 2008 |  |  |  | By:                        |  | /S/ NANCY A. GRAY                     
|                      |  |  |  |                            |  | Nancy A. Gray, Chief Financial Officer



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EXHIBIT INDEX



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



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